# Interest

Everyone will be expected to know:

• What interest is
• About simple vs compound interest

Money Twist trainers:

• How to calculate interest rates

IMPORTANT FACTS- Interest

Interest is the reward for lending and the cost of borrowing. The interest rate is the percentage rate charged on a loan or paid on savings. For example, an annual interest rate of 5% means £5 is paid in interest for every £100 saved or borrowed.

IMPORTANT FACTS- Simple v. compound interest

• Simple interest is where you just pay interest on the original amount that is borrowed (the principal).

– In this example, the interest rate is calculated on a yearly basis.

– If I borrowed £100 at 10% annual interest rate then at the end of the year, I would have to pay £10 in interest.

– In total I would have to pay back £110 (£100 principal and £10 interest). If I borrowed £100 for 2 years at 10% then I would have to pay back £120 (£100 principal and £20 interest).

• Compound interest is where you pay interest on the original amount that is borrowed (the principal) and all on the accumulated interest.

– In other words, interest is added back to the original amount borrowed.

– If I borrowed £100 with compound interest at a 10% annual interest rate, after a year I would pay back £110 (£100 principal and £10 interest).

– If I want to keep borrowing the money for another year then I will have pay 10% on the original £100 and the £10 interest from the first year. This would mean that I would have to pay 10% on £110 which is £121.

• For shorter time frames, there might not be a significant difference between simple and compound interest but as lending time increases, the difference between the two types of interest grows. So if I borrowed £100 for 5 years with compound interest then I would have to repay £161, compared to £150 with simple interest. Most commercial loans use compound interest.