Financial Literacy: Interest
09/24/2025
Financial Literacy: Interest
Interest is one of the most fundamental financial literacy topics that all people can benefit from learning more about. Once you understand interest, you can more confidently borrow and save money to help you reach your financial goals. This week, we’re going to take a deep dive into interest. Let’s get started.
There are two instances where interest comes into play: interest you earn and interest you pay. When you put your money into CDs, certain savings accounts, and investment accounts, you earn interest. On the opposite end, when you borrow money, like for a mortgage or credit card, you pay interest. The interest you pay or earn is determined by the financial institution with whom you open the account. The financial institution uses market conditionals to set interest rates which are usually shown as a percentage.
Let’s break this down even further. What interest you pay or earn depends on the “principal.” The principal is the initial amount either borrowed or deposited. To determine how much interest you will make, you need to multiply the principal by the percentage rate. Depending on the terms of your loan or investment, interest can be calculated monthly, quarterly, annually, et cetera. Most commonly, loans have an annual percentage rate, and investments see gains monthly or quarterly.
But what happens to things over time? If you have invested money, your interest earnings will increase your balance. If you have borrowed money, your payments will usually decrease your balance. This is where simple versus compound interest comes into play. Simple interest is interest that is ONLY calculated off the principal amount. If you initially invest or borrow $10,000, interest will only ever be based on this amount. On the flip side, compound interest is based off the principal and accumulated interest. So, if you invest $10,000 and make $400 in interest in the first year, next year your interest amount will be based off $10,400. Alternatively, if you borrow $10,000 and accrue $400 in interest on the loan, the interest you owe next year will include that $400.
And this is why understanding interest is so important! If you want to maximize earnings on investments, it is important to know that compound interest is where you will earn faster gains. Over a period of ten years, you will have made significantly more from an account that has compound interest than one that has simple interest. However, taking out a loan that accrues compound interest can be more difficult to pay off quickly. With compound interest loans, your debt can grow exponentially and getting behind on payments can make it difficult to catch up. If you can, borrow money that has simple interest.
Learning about interest is essential to being financially literate and making informed decisions. If you would like to go even further into learning about interest, there are many great resources available for free online!
Sources:
https://finred.usalearning.gov/saving/UnderstandingInterest