Interest can turn a line of credit into a trail of debt if not managed properly. So listen up, Gen Y: it’s time to buckle down and show some interest in interest.
What is it?
Interest is a fee that a lender charges you to borrow money. The lender could be a bank, a corporation or even your dad. This is how the lender makes money off of the transaction. The reason we have interest is as a way to compensate the lender for their troubles. For example, I’m sure your dad would have much rather invested his money in a new car instead of loaning you money to replace the transmission on your fixer-upper.
Save now, ball later
When a bank loans money, it’s technically giving someone else your money. No need to panic, though. Banks try to encourage people to keep money in savings accounts in their branches so that they can lend it to other people while you aren’t using it. Banks incentivize this by having savings rates, which help grow your money.
That same interest rate that you have to pay on your loan allows the bank to turn around and pay interest to the original owner of the money. So, the more you put away in your savings account, the more interest you are paid back over time. Basically, you can make money by letting it sit there and look pretty. Granted the savings rates aren’t stellar, but your money will be worth more over time which is well worth a fist-pump and a “Booyah!”
(Pssst…You also do this with the government, except you loan it money through bonds!)
Interest rates
While interest rates are constantly fluctuating, there are three things that the rates depend on: whether the loan is secured, your credit score and the term length of the loan.
Secured vs. Unsecured: Loans that are “secured” are backed by some sort of collateral, like a house or car. And – you guessed it – “unsecured” loans aren’t backed by anything. That’s why credit card interest rates are generally high, because a loan backed by a promise is a lot riskier than a loan backed by a house.
Credit Score: The higher your credit score, the lower your interest rate will be. Who wants to loan someone money if he or she isn’t responsible enough to pay it back on time? No one! Make sure you monitor your credit so you can get the best deal possible.
Term Length: Long-term loans have higher interest rates than short-term loans because the longer the loan, the greater the risk that you might default.
There are so many variables out of our control when it comes to setting interest rates. The only thing we can do to try and make our lives a little easier is by keeping a good line of credit.
That’s all, folks
The bottom line is that interest rates can make or break your bank account. While it is possible to actually make some money through savings rates, paying interest can drain your bank account in 2.5 seconds if you aren’t careful. Now start paying back your dad for that transmission – after all, that interest rate ain’t gettin’ any lower!
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