# A Simple Guide to Understanding Interests – What to Know

Feb 20, 2020

In its simplest and purest definition, interest is a payment made for using other people’s money over a certain period. When you lend money, you earn interest. However, when you borrow money, you are the one paying the interest rates.

There are various ways to calculate interest rates, and some techniques are more helpful for lenders than borrowers. The rate of payment can either be a variable amount or a fixed amount throughout the duration of the deposit or the loan.

Interest is computed as a percentage of a deposit or loan balance that is paid to the bank or lender periodically. The rate is generally quoted annually, but can also be shorter or longer than a year, which typically depends on the agreement. Take note that interest is the additional amount that must be paid on top of the original amount borrowed. The amount that you will have to pay for the interest depends on the following factors:

• The amount of the loan borrowed
• The interest rate
• The duration of repayment

Another factor you must be wary about when it comes to interest is that a longer-term loan or higher interest rates normally results in the borrower paying more than what is expected.

Below are three types of interests that you should know about:

Simple Interest

Calculated as the percentage based on how much you deposited, the interest will be the same in each period. This means that, if you make a deposit of R500 at a two per cent interest rate paid annually, you earn R10 per year.

Compound Interest

In this case, interest is earned or charged based on the amount available per period. It means that it will include the interest accrued from the last period and added to the original amount. For example, the bank starts paying you R510 based on the initial R500 you deposited at a 2 per cent interest rate. As a result, your next payout will be based on the total amount that has accumulated over each period.

Compound interest is mostly used by lenders and banks to calculate interest on savings accounts and loans. Although it may seem like a huge increase, if you think about it closely, it is one of the most simple and effective ways to earn money from your money.