Interest
When you borrow money to buy a car or a house you are not only expected to pay back that money, but to pay interest on it, too. Interest is a fee paid by a borrower to the lender for the use of money. It is calculated as a percentage of the loan amount. When you deposit money into a savings account or certificate of deposit or buy a savings bond, you are loaning money and so you are paid interest. Interest plays an important role in economics because it serves as an incentive for those with available money to lend it to those needing it. There are many different ways that this fee is expressed and calculated.
Types of Interest
The term "simple interest" refers to a percentage of the loan that must be paid back in addition to the original loan. For example, if you borrow $1,000 at 10 percent simple interest and pay it back five years later, you will pay back the $1,000 plus 10 percent or $100 additional dollars for each year, a total of $500 in interest.
Few loans, however, are actually based on simple interest. Loans are usually based on "compound interest," where the total of the outstanding original money and the accumulated interest are calculated on a regular basis to compute the interest owed.
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