What is interest?

What is interest?

Interest is the price paid for using someone else’s money. It is thus the fee for the privilege of borrowing money. The fee represents the price a person pays for the ability to spend / consume in the present instead of having to wait for the future to do so. You pay for the opportunity to use money today that would otherwise take time to accumulate.

A simple example to use is that when a person puts money in the bank and leaves it there, the bank pays the person interest for allowing the bank to use it. If the person borrows money from the bank, the bank will charge the person interest for using his or her money.

The Oxford dictionary defines interest as: “The charge made for borrowing a sum of money. The interest rate is the charge made, expressed as a percentage of the total sum loaned, for a stated period of time.”

Simple interest

Simple interest means interest that is earned or paid on a fixed amount. Simple interest is calculated once. It is calculated for the full term on the principle amount. To calculate how much interest a person will earn on an amount of R5000 at a simple interest rate of 10% for 3 months, the following formula will be used:

Amount X 10% = interest a person will earn.

Compound interest

The money a person earns in interest becomes part of the principle amount and also starts to earn interest. Compound interest is calculated during the term. To calculate the interest a person will earn on an amount of R5000 at a compound interest of 10% for a year the same formula is used as normal interest.