How Interest Works

Interest can be a powerful tool in your financial success, but what it is and how rates are determined?  Corey Blake joined us fron New Horizons to help explain interest.

Below is a list of questions and answers they discussed on Studio10.

What is interest?
In basic terms, interest is the cost of borrowing money. If you borrow money, you will pay interest to the lender. If you save money (in an interest-bearing account) the bank will pay you interest.  You’ll see interest expressed as Annual Percentage Rate (APR) or Annual Percentage Yield (APY).

What’s the difference between APR and APY?
The APR is the annual rate of interest your money will earn, without taking into account any compounding of interest within that year.
The APY is the annual rate of interest your money will earn in one year, and does take into account compounding interest.
Simple Interest is interest paid on principal—the original sum of money invested.
Compound Interest is better for saving, because it allows you to earn interest not only on your initial deposit, but also on the interest that accumulates. Compound interest is added to the principal automatically when it is paid, and interest payments after that are figured on the whole sum: principal plus interest.

How Are Interest Rates Determined?
The U.S. Federal Reserve raises and lowers interest rates to maintain the stability of the United States financial system. The Federal Reserve regularly takes action on interest rates in response to economic ups and downs.  When interest rates are high, you earn more interest on your deposits, but you also pay higher interest rates on any money you borrow. When interest rates fall, you earn less interest on your savings, but it costs less to borrow money. Some institutions pay more interest on higher balances to reward account holders who have higher savings amounts.  Credit unions don’t have investors to pay and typically give a higher rate on savings for their members. This is one of the advantages of being a member of a credit union.

New Horizons Credit Union
www.newhcu.org


Sponsored by New Horizons Credit Union