Interest is money you earn on your savings or pay for borrowing. Compound interest is money you earn on both the money you save and the interest you earn on that saving. So every year you earn interest, you also earn interest on the interest itself.
Compound interest is great when you’re saving. Here is an example:
Imagine you paid SR 1,000 into a savings account with an annual interest rate of 10%.
- By the end of the year, you’ll earn SR 100 in interest, making your total SR 1,100.
- The following year, you’ll earn SR 110 in interest (10% of the original SR 1,000 and 10% of the year 1 interest), making your total SR 1,210.
- The year after, you’ll earn SR 121 in interest (10% of the original SR 1,000 and 10% of the year 2 interest), making your total SR 1,331 and so on.
Compound interest is not so great when you borrow. Compounding debt interest can seriously add up when you borrow large sums of money over a long period. It can end up costing you a lot more.
When do you pay interest?
You’ll pay interest on several different types of borrowing. Here are some examples:
- Credit cards. You’ll get charged interest if you don’t pay your monthly credit card statement in full.
- Mortgages are loans to buy houses. They’re usually long-term loans you repay over 25-30 years. You’ll pay interest at a fixed or variable rate (which changes during the loan period). But your interest payments should reduce over time as you gradually pay off your original loan amount.
- Car loans. You might take out a bank loan when you borrow money to buy a car. Or take out an auto loan offered by a car dealer. Auto loans are short-term loans of up to six years, and interest is usually charged at a fixed rate.
- Student loans. Loans for university education are currently capped at an interest rate of 6.5%. Paying off a student loan and the interest depends on your salary and the threshold for your monthly income.
- Invoices. Some firms charge you interest instead of late fees if you don’t pay your invoice on time.
When do you earn interest?
You earn interest on money in savings accounts and some current accounts. There are several different kinds.
- Regular/traditional savings accounts. Most traditional banks and building societies offer regular savings accounts.
- High-yield savings accounts. Banks also offer high-yield savings accounts. They pay higher interest rates but may tie your money into a set period of time.
- Pension savings account. There are different types of pension accounts with varying long-term interest rates. You can also open a child pension account, which is a long-term savings account with interest.
- Kids’ savings accounts. These are designed for kids under 18 and must be opened by a parent or guardian who acts as a joint account holder.