Why Is Simple Interest Useful For Planning Parts of Your Financial Future?

Why Is Simple Interest Useful For Planning Parts of Your Financial FutureWhy Is Simple Interest Useful For Planning Parts of Your Financial Future?

This is a question I ‘ve seen in a quiz. I thought that apart from the actual answer, I could also go over the real-life implications.

If you are not yet familiar with the term – interest is the percentage of your savings or your debt. Depending on which side of the balance sheet you are on 🙂

In case you have put money into the savings account, you want the interest to be as high as possible. So you can earn more on your savings.

While if you are taking out a loan, you want your interest to be a low as possible.

In case you stumbled upon this post while looking for a reply on Why Is Simple Interest Useful For Planning Parts of Your Financial Future?

Here is the answer – Simple interest is very regular and can be calculated in advance.

For those of us looking to get a better understanding of your finance – let’s continue.

As mentioned above, we are looking at interest from two perspectives. Are we paying it or are we getting it?

Simple Interest

In the case of simple interest, everything is quite easy. It is exactly as it sounds.

It is set at the beginning and it continues to be charged at the same pace.

Simple interest is predictable. That is what makes it useful for planning.

Let’s take the example of savings on simple interest. You deposit $1,000 at 1% interest for 3 years.

The result would be $1,010, so a $10 profit. For year two it would be the same $10 again and for ear 3, again additional $10.

Compound Interest

The difference between simple and compound interest is drastic.

Compound interest is “interest from the interest”.

So if we would take the example above. the first year would be the same, you would be sitting at $1,010.

But for the second year, you would be getting 1% from these $1,010, so you would get $10.1. On year 3 we are getting 1% from 1,020.1

So now we are at a total of $1,030.3.

Sure, it does not seem that much in 3 years’ time and $1,000 saved, but it adds up.

If you want to get into more depth on compound interest here is a wiki that goes into all the corners fo this topic.

APR  – annual percentage rate

APR represents the overall cost that you would pay on your loan. It should include the prime rate plus the margin that the lender charges.

Variable interest

This interest is usually tied to the changes in the base interest rate.  If you are wondering where to find this base interest rate, you can check with your national bank.

It goes like this “Your 3 Month Base Rate + Lenders Margin. On a 1 year loan”. As base rates changes – so does the final interest for you.

Fixed Interest

The exact opposite of the variable interest. You fixate the variable rate, and that is your final interest for the whole length of the loan.

I hope this quick review of the interest will help you navigate both the debt and savings aspects of your finance!

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