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  • 5m.
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    How Interest Helps And Hurts Your Finances

    It pays to understand all the ways that interest rates can work for and against you in different financial situations.
    Updated: February 26, 2016
    Infographic about interest

    The Most Interest-ing Infographic In The World

    Interest is one of the most important factors to know about when it comes to your finances—and it's easier to grasp than you may think. Basically, interest is the cost of borrowing money.

    The average American household pays $6,658 in interest every year. That's 9% of the average household income! You don't have to be an international man of mystery to pay less; you just need to understand interest rates.

    I don't always borrow money ... but when I do, I choose a low interest rate and repay quickly.

    When you take out a student loan, finance a car, or use your credit card to buy a cup of coffee, you're borrowing money. You usually pay back more than the amount you borrow, because of interest—and if your interest rate is high, you pay even more.

    Fixed Vs. Variable Interest

    Interest rates can be "fixed" or "variable." A fixed rate remains the same for the entire lifetime of your loan. Variable rates can shift (typically annually) based on market factors.

    My college once took out a student loan to pay for me.

    Here's how interest affects the amount you have to pay back:

    Let's say you borrow a $10,000 loan with a 4.29% fixed interest rate.

    Your balance increases by 4.29% each year, with interest likely accruing daily on any amount you owe. Every payment you make reduces your balance, which in turn decreases the interest you'll accrue.

    With payments of about $103, it will take 10 years to finish, and you'll pay $2,315 in interest.

    Amount borrowed: $10,000
    Interest Rate: 4.29%
    Monthly payment: $103
    Repayment duration: 10 Years
    Total amount repaid: $12,315
    Total interest paid: $2,315

    By reducing that interest rate to 3.00%, you'll pay less each month while saving hundreds on interest!

    Amount borrowed: $10,000
    Interest Rate: 3.00%
    Monthly payment: $97
    Repayment duration: 10 Years
    Total amount repaid: $11,579
    Total interest paid: $1,579

    Increase your monthly payments to $125 to save even more in interest—and finish repaying faster!

    Amount borrowed: $10,000
    Interest Rate: 3.00%
    Monthly payment: $125
    Repayment duration: 7.5 Years
    Total amount repaid: $11,171
    Total interest paid: $1,171

    My money doesn't always accrue interest … but when it does, it accrues compound interest.

    You can use interest to your benefit by keeping your money in an interest-bearing account. When you do this, you're technically loaning money to the bank—and they pay interest to you. That interest capitalizes each month (meaning it's added to your balance), and you start earning interest on the interest. That's called compound interest, and it can really help put your money to work for you!

    Simple Vs. Compound Interest

    Some accounts pay simple interest, which only accumulates on the principal balance you deposited—not on any accrued interest that has previously capitalized. You'll still earn money with simple interest, but it will take longer to earn the same amount as you would with compound interest.

    I don't work for money. Money works for me.

    Here's an example of how compound interest works:

    Let's say you put $1,500 in an online savings account with a 3.00% interest rate. After a year, you'll have accrued $45.

    If that account earns compound interest, the next year that $1,545 will earn another $46, and the following year it will earn $48.

    After just 5 years, you'll have $1,739!

    Year 1 initial balance: $1,500
    Year 1 interest earned: $45

    Year 2 initial balance: $1,545
    Year 2 interest earned: $46

    Year 3 initial balance: $1,591
    Year 3 interest earned: $48

    Year 4 initial balance: $1,639
    Year 4 interest earned: $49

    Year 5 initial balance: $1,688
    Year 5 interest earned: $51

    Balance after 5 years: $1,739

    If your account earns simple interest, you’ll accrue just $45 every year.

    Stay money-savvy, my friends.

    Sources:

    American Student Assistance® (ASA): Internal Research: asa.org

    CalcXML: calcxml.com

    FinAid: finaid.org

    NerdWallet, Inc.: nerdwallet.com

    It pays to understand all the ways that interest rates can work for and against you in different financial situations.
    Actualizado: 26 febrero 2016
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