What is Debt Interest?

What is Debt Interest?

What is debt interest?

Interest is the fee you pay for borrowing someone else’s money. The borrower pays interest to the lender who lets them use the money. You are charged interest in a few different ways, but the general idea is the borrower pays back their loan over time with an additional fee on each payment. 

How is interest charged?

You are typically charged interest as a percentage of the amount of money you borrow. The percentage you pay can be calculated yearly, called the annual percentage rate (APR). Beyond the percentage you pay, you can be charged interest in different ways.

What is simple interest?

When you borrow money, simple interest is based on the original amount of money you borrow, and you pay the same amount back on your loan each month. If you get a loan for $1,000 with a 5% APR, you’d owe $50 in interest each year on top of paying the loan back. Auto loans are a common simple interest loan where your payments stay the same and spread out evenly over time.

What is compound interest?

Compound interest on unpaid debt and interest that keeps growing. Credit cards and other kinds of loans work using compound interest. When you make a payment on your credit card, you pay interest on your total balance. The total amount you still owe and any unpaid interest carries over to the next month, and you’ll pay interest on the new balance. Interest compounds when the old interest charges carry over, and you pay interest on it again. 

Teach kids what interest is and how it affects them

If your teen wants to buy a car or go to college, they probably can't pay the whole amount up front, so they’d likely borrow money. Interest will impact their payments and overall finances. Show them how interest rates can impact their money down the road. Teaching kids about interest and how it all works from a young age will help them become smarter spenders and borrowers.

Read more articles about explaining credit and money borrowing to kids.

Written by Kristin Yarbrough Published Jul 6, 2022 ● 2 min. read