1.3 Interest

Explaining the Concept of Interest as the Cost of Borrowing Money or the Return on Savings (2 minutes):

“Interest is a fundamental concept in finance, and it plays a pivotal role in both borrowing and saving money. Let’s explore how interest functions as the cost of borrowing and the reward for saving.

1. Cost of Borrowing Money:

• When you borrow money, whether it’s in the form of a loan, a credit card balance, or a mortgage, the lender typically charges you an additional amount over the borrowed sum. This extra amount is known as ‘interest.’
• Interest serves as the cost of borrowing. It’s the price you pay for the privilege of using someone else’s money. The interest rate is usually expressed as a percentage of the principal amount borrowed, and it represents the compensation the lender receives for taking on the risk of lending.
• For example, if you borrow $1,000 at a 5% annual interest rate, you’ll owe $1,050 at the end of the year. The $50 is the cost of borrowing the $1,000.

2. Return on Savings:

• On the flip side, interest is also a reward for those who save or invest their money. When you deposit money in a savings account, invest in bonds, or put funds in a certificate of deposit (CD), you’re essentially lending your money to a financial institution or issuer.
• In return for lending your money, these institutions promise to pay you interest. This interest serves as a return on your savings or investment. It’s a way for your money to grow over time.
• Consider a savings account with a 2% annual interest rate. If you deposit $1,000, you’ll earn $20 in interest over the course of a year. This $20 is your return on savings.

In conclusion, interest is a financial transaction that serves a dual role. It’s the cost you pay when you borrow money, and it’s the reward you earn when you save or invest your money. Understanding how interest works is crucial for making informed financial decisions, whether you’re looking to manage your debt wisely or grow your wealth over time.”