Interest vs interest rates: How does it work?
Financial literacy is the key to making good financial decisions. This includes not only understanding the meaning of different financial terms but also having a clear understanding of how certain factors can impact your personal finances. In this article, we look at interest and interest rates, and how they can impact you, the average consumer.
What is interest?
Interest can be defined in 2 different ways. It is the cost of borrowing money from a financial institution such as a bank, so, for example, if you borrow money from the bank, you will be charged a percentage of the principal (the amount you loaned), and that percentage is interest.
Interest is the money you earn from your savings. When you put your money in an interest-bearing bank account such as a savings account, interest is the return you receive on your savings from the bank.
The amount of money you pay or earn in interest is dependent on the following factors:
- The interest rate
- The amount of the loan
- How long it takes to repay
What is an interest rate?
Interest rate refers to the cost or return as a percentage of the amount you are borrowing or saving. Different countries have different interest rates, which change over time depending on market conditions. As of November 2021, South Africa’s interest rate rose from 3.5% to 3.75%*.
The interest rate can affect your personal finances in a number of ways. For example, when the interest rate is low, borrowing becomes cheaper, meaning more people are likely to take out loans or buy things on credit. Low interest rates can be good for the economy because people are more willing to spend money on products and services. People are also likely to have more disposable income at this time since the cost of paying back their loans or credit is low.
When the interest rate is high, borrowing is more expensive, meaning some people will either rethink the idea of borrowing or have less disposable income as they are repaying their existing loans at a higher rate. High interest rates, however, are good for those who are saving money as they will get a better return on their savings or investment accounts.
When deciding to make big financial decisions such as taking out a home loan or opening a type of savings account, you should make sure that you research the current interest rates to determine whether it is the right time to do so.
*Information correct at date of publication.