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How Does Interest Work? 4 Things You Need to Know

Most important financial decisions that a person makes have some kind of relationship to the idea of interest.

Interest can seem complicated, but it’s actually relatively simple once you get the general idea. There are different kinds of interest, and all of them claim to have some kind of benefit over the other kinds.

In order to prevent getting caught with a poor financial deal, you should understand interest and do the math on your situation before entering into a deal.

But before you can do this you have to understand the concept. So, how does interest work?

How Does Interest Work?

Interest is essentially a way for money multiply without doing anything. For significant interest to accrue, you need to have a significant amount of value within an account. This is why banks and other financial institutions make so much money off of the loans that they give and money that they hold.

Essentially, interest accrues at a pre-determined rate. So, say that you go into a bank and ask for a loan. To make the math easier, we’ll say that the R100,000 loan has a 10% annual interest.

This means that if that loan goes unpaid for one year, an interest of R10,000 (10% of R100,000) will be added to the amount that needs to be paid back. Many loans have annual interest rates that are accrued monthly. If you are in an agreement that has monthly interest on an annual rate, there’s an easy way to figure out how much you’ll be paying each month.

How to Calculate Your Interest Rates

In order to know how much interest you will be paying every month, apply the following equation. You first need to take the principal amount on your bill. This is the amount of money sitting, before interest, that needs to be paid back.

Say that you’re one year into that R100,000 loan, so your principal would be R110,000. You then apply the annual interest rate to that number, finding out how much interest you would be paying over the next year if your principal stayed the same. So, 10% of 110,000 is 11,000.

That 11,000 is going to be the total amount of interest you would pay that year if you didn’t make any payments. You will likely be paying monthly, so in order to find the amount you’ll pay monthly, you need to divide that number by 12. We divide by 12, of course, because there are 12 months in each year.

11,000 divided by 12 comes out to 916.6. The total monthly interest rate that you would be paying on your R110,000 loan would be 916.6.

How to Approach Paying Off Loans

You should not wait to start paying your loans. The nice thing about the monthly rate is that it only takes the percentage out of your principal amount, which will get smaller if you start to pay your loan.

Interest doesn’t wait for anyone, and it will continue to grow as long as it can. It is a powerful thing, as it simply continues to grow and grow exponentially as your principal investment.

Need a Loan?

Hopefully you can now answer the question, “how does interest work?” If you’re interested in getting a loan in South Africa, we have helped over 100,000 people already. There is no paperwork, and we will never charge fees.

If this sounds good to you, contact us and we can get started today.