What is Interest? Why Does it Matter?
Joshil Sangtani
Staff Writer
Interest plays a major role in your financial life, whether you realize it or not. It is the sole determinant on how fast your savings grows, how expensive your debt can get, and how small financial decisions can have major consequences. The difference between building wealth and accidentally destroying it, all stems from the word interest. So what is it, exactly? In short, interest is either the cost of borrowing money, or the reward you get for saving it. In personal finance, interest shows up in two main forms: interest you earn on your savings (the good kind) and interest you pay when you borrow (the dangerous kind).
Interest you earn is how your savings grows. When you put money into an interest-bearing account, like a high yield savings (HYSA), a certificate of deposit (CD), or a money market (MMA), the bank pays you interest for letting them use your money. This “reward” is usually expressed as APY (annual percentage yield). APY shows how much you earn on savings over the course of a year, while APR (which we will discuss shortly) shows how much you pay when borrowing; a simple but critical difference to keep in mind. For example, let’s say you put $1,000 into a CD that pays 4.5% APY. You will earn around ~$45 in interest over the year without having to do anything. And the higher the APY and longer you leave your money untouched, the more it continues to grow. This growth happens automatically over time, without any extra effort from you.
Interest you pay is the other side of the coin, that works against you when you owe money. Credit card, personal or student loans, “buy now pay later” plan, etc. are all examples that charge you an APR (annual percentage rate), essentially the yearly cost of borrowing. Credit card APRs are often the most dangerous due to their ranges of 20% to even 30%. For example, if someone makes a $1,000 charge on their credit card with a 25% APR, and chooses not to pay it off, that balance can grow quickly. Interest compounds monthly, leading to the debt owed to balloon a lot faster than expected. This is exactly how majority of people fall into long term debt without realizing how rapidly interest can accumulate.
There is also compound interest, which is the process of earning interest on both your original money and the interest that has been added to it. Compound interest has the power to turn a minor cash investment into exponential growth, simply by taking advantage of time. Small, consistent contributions become meaningful long-term results. For example, investing just $200 a month at an average return of 8%, starting at age 25, can grow to more than $350,000 by retirement age (65 years old). On the contrary, someone who decides to wait until 35 to start investing the same amount, will end up with less than half of that. Time is the key determinant; compound interest is the reward for those who begin now.
Interest matters because of its role in every financial decision you make. It determines how quickly your savings can accumulate, how expensive your debt becomes, and how much wealth you can build over time. Understanding the different types of interest, especially compound interest, will help you dramatically in avoiding common financial traps while also giving you the tools to make intelligent long-term choices. More advanced financial products (like Treasury bonds or corporate debt for example) also earn interest, but most students will first encounter interest through savings accounts and loans. If you understand how interest works, you’ll understand how money as a whole works. Whether you want to save, borrow, or invest, make it a priority to master the fundamentals of interest and dramatically improve your financial future.
Contact Joshil @ joshil.sangtani@student.shu.edu