Interest

Interest summary:

• Interest is a major part of the cost to take out a loan. 

• Interest rates can be fixed (stay the same over the life of the loan) or variable (subject to change). 

• Simple interest is calculated based only on the loan, while compound interest is when interest is also calculated based on interest already owed. 

Interest definition and meaning

Interest is the amount you pay to borrow money. 

Lenders can charge interest for different types of loans, including personal loans, home equity loans, and HELOCs. There are two types of interest for consumer loans: simple interest and compound interest. Compounding tends to make the amount of interest bigger. Credit cards typically charge compound interest. Installment loans typically charge simple interest.

Key concept: Interest is how much a lender charges you for borrowing money. Compounding interest could increase the total cost of the debt.   

More about interest 

Most of the time when you borrow money, you’re responsible for repaying more than just the amount you borrowed. You’ll also have to pay interest. 

Interest rate types

Interest rates are either fixed or variable, depending upon the type of loan. Here’s the difference between the two:

• Fixed. A fixed-rate loan means the interest rate never changes. The rate remains the same from day one to the time you pay the loan in full.

• Variable. A variable interest rate could change during the term of your loan. This means that your payment could go up or down throughout the life of the loan. A variable-rate loan is sometimes called a floating-rate loan. 

Related: Fixed-rate HELOC: Why it’s the best kind

Interest: a comprehensive breakdown 

One factor that can impact how much you pay for a loan is whether the interest is simple or compound. Here’s how simple and compound interest are different:

• Simple interest. Simple interest is calculated only on the loan balance. Let’s say you borrow $50,000. You’ll only pay interest on that amount. Most personal loans and home equity loans carry simple interest. 

• Compound interest. Compound interest is interest on interest. Compound interest could make it more expensive to pay off a debt. Credit cards use compound interest. If you don’t pay off your full balance, you’ll be charged interest. The next month, the card issuer will charge interest on the amount you owe, including the interest that was previously added to your balance. 

As a borrower, you’d prefer a simple interest loan, because it saves you money. As an investor or saver, you’ll appreciate the power of compound interest to help your money grow.