Since it's National Financial Literacy Month, we're getting back to basics. Today's post covers interest: The kind that helps and the kind that hurts.
Despite its name, many people do not find “interest” particularly interesting. Which is unfortunate, because a proper knowledge of interest will make a huge difference in your financial life. That’s why we spoke to the experts to create a handy dandy guide to interest that we hope you’ll find interesting. Or, at the very least, that you’ll find compelling enough to read on your phone while sitting on the bus.
Does your bus ride currently provide a helpful dose of financial advice? Well, now it can!
Interest has been around for a very long time. Even longer than money itself! Essentially, it’s a way for those with resources to get compensation for lending out the aforementioned resources. We give you four cows. You then use those cows to make more cows. One year later, you give us back five cows. As long as you still have some cows left over, we’ve both come out ahead.
When you take out a loan, unless it’s from a friend or family member, you’re almost certainly going to have to pay some interest. The amount will vary, but it will be a percentage of the total loan amount, or principal. The loan may also come with additional fees, which is why it’s important to compare different loans in terms of their APRs, or Annual Percentage Rating. A loan’s APR is a measure of its total cost, including fees and interest.
But you can also make interest work for you! One way to do that would be to start a bank or other lending institution. But an easier way to do that is by putting your money into an account that yields interest, as most accounts do. That’s because when you put money into a bank account, you’re actually lending money to that bank.
So how can you make sure you’re always handling interest as well as possible, regardless of whether you’re paying or receiving it? Keep reading and see!
You have to put your money somewhere. Sure, you could keep it all in your pockets, but that’s just asking for trouble. And while keeping it under your mattress might be a classic, it’s almost as risky as just keeping it in your pockets.
That’s why most financial advisors will recommend you keep your money in a bank account. And, as we previously mentioned, this technically means you’re lending money to the bank and will be receiving interest in return. But if you want that interest to be substantial, you’ll need to choose the right account.
“If you want to maximize the interest you receive on your bank accounts, it pays to try and start with the most favorable conditions,” suggested Stephen Hart, CEO of Cardswitcher. “Before you even start saving, make sure that your account is one that returns a high rate of interest. Shop around as much as possible, comparing deals to see which offers you a better return. Also, check the rewards that are associated with particular bank accounts, as sometimes you can find these can influence your interest rates.”
Finding the right bank account isn’t your only opportunity to be a lender, however.
“The best way to get the best of both sides of the interest coin is to be a lender and not a borrower,” advised Steven Nuckols, president and founder of Wealth Compass Financial. “Interest rates are going to continue to rise, although slowly, and lenders will be getting paid more for their money. For most people, this means better returns on bank accounts, CD’s, and new bond issues. A roundabout positive is that banks will have higher margins and will be able to offer more incentives to customers through credit card rewards, bonuses, and interest rates on products.”
But you can’t always be the lender.
A loan again.
Unless you have a swimming pool full of cash in one of the rooms of your house, you’re probably going to have to take out to get a loan at some point. For example, every time you use a credit card, you’re technically taking out a loan. Fortunately, it’s one of the few kinds of loans you can actually avoid paying interest on at all.
“If you’re looking to reduce the amount of interest that you have to pay on your credit card account, one of the most effective techniques is to just ensure that you pay off the amount in full every month before the grace period ends,” urged Hart.
When it comes to every other kind of loan, you’ll want to shop around to find out which options have the lowest APR. The sooner you can pay down any loan, the less you’ll have to pay in interest. You do need to be careful, however, as some loans come with a prepayment penalty that will punish early payment.
If you have bad credit, you’re going to find yourself stuck with much higher interest rates.
The answer to that quandary is simple: Raising your credit score will allow you to get personal loans at better rates! We’ve written about how you can improve your credit score multiple times, like here for example. (And in the meantime, a well-stocked emergency fund will help you whether any surprise bill or financial shortfall.)
At the end of the day, interest is pretty simple. You want to get it, rather than having to pay it. If you are getting it, you want to get as much as possible, and if you’re paying it, you want to pay as little as possible.
After working in the financial industry for several years, Stephen Hart left his role as Chief Financial Officer at WorldPay to launch the UK’s first payment processing comparison site, Cardswitcher. Nowadays, he helps SMEs save money on their payment processing costs.
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