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The Good and Bad of Interest!
BAD INTEREST
Borrowing money often comes at a cost...and that is interest.
Car loan, student loan, mortagage, personal line of credit, credit card debts, loan sharks...
When you need money, and someone can give you some...they are in charge!
Best case scenario: parent says you need money? Here's some. (free)
OK scenario: parent says you need money? Here's some...and pay me back whenever. (free loan)
less good scenario: Parent says I' can't help you right now. Go get a loan.
The loaner says you can have some, but it'll cost you! Interest, scedule of repayment is up to them!
Worst case scenario: you borrowed some money and can't make your payments to repay on the schedule they asked you to.
Good Interest
When you are the one giving out the money, you gain interest! The perosn who is borrowing your money needs to pay you back the borrowed amount plus some extra!
Simple vs Compound Interest
The core difference is that simple interest calculates returns only on your initial principal, while compound interest calculates returns on your principal plus all the interest you have already earned.
In short, compound interest means you are earning interest on your interest, causing your wealth to grow much faster over time.
A Tale of Two Investors (Visualizing the Break)
Imagine two people each invest $10,000 at a 10% annual interest rate for 30 years.
Investor A (Simple Interest): Earns exactly $1,000 every single year. After 30 years, they have their original $10,000 plus $30,000 in interest, totaling $40,000.
Investor B (Compound Interest): Earns $1,000 in year one. In year two, they earn 10% on $11,000 ($1,100). By year 30, their money has snowballed to a staggering $174,494.
The visual below illustrates how the gap between the two strategies starts small but widens massively over a long timeline:
Simple Interest formula:
Interest = Principal × Rate × Time
Compound interest Formulas:
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