People have spent years, decades, and maybe even centuries arguing about the important role math plays in a child’s overall education and development. While some concepts are more abstract, others are demonstrably valuable and play a key part in each of our adult lives. One topic that falls into the latter group is the concept of interest.
Whether you want to save for some pricey concert tickets, you’re planning to buy your first car, or you’re already saving for when you go off to college, money is a huge factor in every young adult’s decision-making process. Properly understanding the way interest works can be the difference between hitting financial goals and being left behind by friends and colleagues.
Let’s dive a little deeper into the concept of interest, highlight some of the most common examples of interest that we see every day, and uncover how this one mathematical idea can set you up for a lifetime of financial prosperity.
An Interesting Idea
Interest has been around for a long time. Long before coins and similar items came into existence, there is evidence that a system of credit and interest was in use in ancient Sumer around 3000 years ago. But what exactly does interest mean today?
Interest is basically an additional fee that a borrower pays to their lender. Let’s say I borrow $200 from you, a bank, and we agree that I will pay 1% interest on this loan. That means that I will have to repay the $200 plus 2% of this sum, which is equal to $4 (200 x 0.02). So your $200 became $204 without you having to do anything beyond lending me this money.
We can think of interest as being a reward that some people or institutions get for being financially stable, savvy, and willing to take the risk of lending their money to others. At the same time, some people look poorly at this practice and see interest as a reward for taking advantage of another person’s financial precarity. Either way, interest generates a lot of money for lenders, and causes a lot of stress for borrowers.
Types of Interest You Will Encounter
As math students move through high school and into adulthood, they will begin to see interest in many facets of their lives. Some types of interest are quite complex, and many of us do not need to concern ourselves with them on a day-to-day basis. But, there are some types of interest that we all need to be familiar with.
Let’s say you have saved, or acquired, some money. You have enough money that you’ve agreed to lend your friend $100 with the understanding that they will pay you back within a year, and with a little extra payback to show their appreciation. This extra amount is interest, and it is usually calculated as a percentage of the amount lent. This percentage, then, is known as the rate of interest.
If your friend agreed to give you 5% interest on top of the lump sum you lent them, you will receive an extra $5. That means that simply by having the means to lend $100 and knowing someone who needs to borrow money immediately, you have turned your $100 into $105.
The concept of compound interest is where the magicians disguised as economists truly showed us their capabilities! Compound interest is like interest maximized to the advantage of the lender/investor. With compound interest, your money earns interest on the original sum, but also on the accumulated interest from previous periods.
Let’s look closer with the help of another example, using the same figures as above. Imagine you invest $100 into an account with a 5% annual interest rate compounded yearly. At the end of the first year, you will have $105 (as we saw in the previous example). In the second year, however, you will earn interest on your initial $100 investment and the $5 interest that you gained in year 1. This means your interest in the second year will be more than $5 ($5.25). In year three, your balance will begin at $110.25, therefore earning you interest of $5.51.
Put simply, compound interest accelerates the growth of your money over time in a way that simple interest does not. Don’t take my word for it – test it out using this useful tool and see just how much money you can earn with compound interest.
At the Online Math Center, your child can learn all about the importance of interest, and other mathematical concepts that play a very real and important role in each of our adult lives. Our international team of qualified math tutors boasts years of experience improving students’ math grades.
Whether you need to take advantage of our unrivaled one-to-one math tutoring sessions, you need a dedicated tutor to focus on preparing your child for math competitions or the all-important Math SAT, or whether you just want to help your child plug a few gaps in their knowledge and become more confident in math class, OMC has what you need.