Publications
Partners
Shutterstock [http://www.shutterstock.com]
Johannesburg - Two kinds of interest are common. If you don’t understand the difference – and know what kind of interest you’re paying – you could fall into a deep, dark hole of indebtedness!
Simple interest
You are very unlikely to get a loan on which you pay simple interest, but it’s the way many of us tend to work out what interest we’ll pay on a debt.
If your debt is R1 000, which you are paying off at the end of the year, and the simple interest rate is 5%, or R50, you will have to pay R1 050 at year-end.
If you only have to pay at the end of two years, interest will be calculated at the end of year Two, once more on the principal (the amount of the loan you took): R1 000 at 5% = R50, plus the R50 earned over the first year = R1 100.
If you roll the debt over for another year, the process is repeated: another 5% of the principal = R50, so at the end of year Three you would owe R1 150. And so on.
Compound interest
Compound interest is a different kettle of fish. In this case, interest is paid ON INTEREST.
Let’s take the same example:
Principal: R1 000
Interest rate: 5%
At the end of year One, you owe R1 050. If this amount is not paid, when the end of the next interest rate period rocks around at the end of year Two, the interest will be calculated, not on the principal amount alone, but on that amount PLUS the added interest.
R1 050 x 5% = R52.50
So if you don’t pay it off again, you will now owe R1 102.50.
At the end of year Three, interest will be calculated on that amount:
R1 102.50 x 5% = R55.13
Now you owe R1 157.63.
Now the next thing you need to know is when the interest is calculated: annually? Quarterly? Monthly? Daily?
Most credit cards operate on daily accrued interest. This means that they take your interest rate – currently 17% and upwards for credit cards – and divide it by the number of days in the year:
17 / 365 = 0.046575.
So if you have a balance of, say, R10 000 on your credit card, at the end of each day, you’ll attract interest:
R10 000 x 0.046575 = R4.65
You now owe R10 004.65. And this is what will earn interest the following day:
R10 004.65 x 0.046575 = R4.66
These may seem like tiny amounts, but they begin to mount quite quickly. Imagine what they’ll add up to over 365 days!
Add your voice on the Debt Issue:
Simple interest
You are very unlikely to get a loan on which you pay simple interest, but it’s the way many of us tend to work out what interest we’ll pay on a debt.
If your debt is R1 000, which you are paying off at the end of the year, and the simple interest rate is 5%, or R50, you will have to pay R1 050 at year-end.
If you only have to pay at the end of two years, interest will be calculated at the end of year Two, once more on the principal (the amount of the loan you took): R1 000 at 5% = R50, plus the R50 earned over the first year = R1 100.
If you roll the debt over for another year, the process is repeated: another 5% of the principal = R50, so at the end of year Three you would owe R1 150. And so on.
Compound interest
Compound interest is a different kettle of fish. In this case, interest is paid ON INTEREST.
Let’s take the same example:
Principal: R1 000
Interest rate: 5%
At the end of year One, you owe R1 050. If this amount is not paid, when the end of the next interest rate period rocks around at the end of year Two, the interest will be calculated, not on the principal amount alone, but on that amount PLUS the added interest.
R1 050 x 5% = R52.50
So if you don’t pay it off again, you will now owe R1 102.50.
At the end of year Three, interest will be calculated on that amount:
R1 102.50 x 5% = R55.13
Now you owe R1 157.63.
Now the next thing you need to know is when the interest is calculated: annually? Quarterly? Monthly? Daily?
Most credit cards operate on daily accrued interest. This means that they take your interest rate – currently 17% and upwards for credit cards – and divide it by the number of days in the year:
17 / 365 = 0.046575.
So if you have a balance of, say, R10 000 on your credit card, at the end of each day, you’ll attract interest:
R10 000 x 0.046575 = R4.65
You now owe R10 004.65. And this is what will earn interest the following day:
R10 004.65 x 0.046575 = R4.66
These may seem like tiny amounts, but they begin to mount quite quickly. Imagine what they’ll add up to over 365 days!
Add your voice on the Debt Issue:
