Understanding Interest Rates

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At this day and age, nothing is more crucial than knowing everything you can about handling your finances. In earlier, patriarchal times, only men were allowed to make financial decisions, but that is long gone now. Women and men should both learn how to make financially sound decisions or else you get in trouble. Being an adult is hard, but knowledge is power, and understanding everything surrounding your finances is indeed great power you can possess.

Interest is an amount a borrower pays a lender so that you can use the money. The interest rate is a percentage of the total amount you borrowed. For example, if you borrow $2,000 and you have an interest rate of 10%, then you have to pay back the $2,000 plus the 10% interest. Interest is not entirely bad, but it’s not entirely good, too. Interest rates exist because they are a measure of risk, of how likely you’ll pay the money back. Sometimes, your interest rate will also depend on your credit score. Some companies will look at your credit score to determine your interest rate. A higher credit score will land you chances of scoring lower interest rates. You will get into situations where interest will work on your favor or will work against you.

There is one situation where interest rates will work for you. For example, you have money in your savings account. Let’s say the amount is $5,000, and your bank has a 5% annual interest rate. At the end of the first year, if your balance stays the same, your bank adds $250, so now you have $5,250 sitting in your savings account. If the same thing happens on the second year, then you have $5,512.50. At the end of the third year, you have $5,788.125. If you keep it up, by the fifth year, you get around $6,381.41. It may not seem much, but if you also add a bit every now and then, it will certainly become a bigger amount eventually.

Here is also one situation where interest rates won’t be your best friend and that is when you’re borrowing money. For example, your credit card company has an annual interest rate of 20% and you owe them $5,000. If you fail to make a single payment, by the end of the year, instead of owing them $5,000, you now owe them $6,000. That’s an extra $1,000 you have to pay back! If you think about it, you could have used this money to pay for other bills, but instead it just goes straight to paying off debt. The same goes for mortgages, college loans, and other types of loans.

To get your finances in check, take advantage of the good interest (your savings), try to get rid of the bad interest (paying off any kind of debt), and avoid incurring more debt. Managing your finances can seem hard at first, but the more you understand, the easier it is for you to be in control.