My niece is already getting ready for college next fall—her test scores are in, the acceptance letter is taped to the mirror in her bedroom, and now we are working our way through student loans. As we were discussing her options, I asked her to make sure she considered loans that had the best interest rate in addition to loan terms.
She looked at me like I was speaking another language. "What do you mean interest rate?" she asked. "The only interest I know about is what my bank pays me on my savings account and a CD I have."
Whoops—I realized we had an information gap here on interest! This called for a quick "interest" conversation.
OK, let me make this easy. When you deposit your money in a savings account or CD(Certificate of Deposit), the bank or credit union pays you for having that account. They use your money and other depositors' savings to lend money to their other customers, so they pay you interest to use it. Think of it as rent—the bank is renting your money. The more money you put in and the longer you keep the money in your account, the more interest you'll get paid over time.
Now the flip side is this: When you borrow money for something you want, like an education, a car, a home, etc., the bank or credit union charges you interest. Here, you're renting the money from the bank, so you pay the interest. The interest a financial institution charges for loans is not only how they make money but also how they have money to pay you interest on your savings. And the interest rate you pay will vary depending on how much—and for how long—you borrow.
After a couple of minutes, my niece looked at me and said, "Wouldn't be easier just to say when I deposit money I earn interest, and when I borrow money I pay interest?"
She's right—fewer words and right to the point.
Anything about earning or paying interest you find perplexing?
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