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Whether you’re borrowing money or trying to save for the future, interest can play a big role in the decisions you make. Understanding it can help you make better choices, make the most of the earnings on your savings, and avoid repaying more on money you borrow.

What is interest?

Interest is the cost of borrowing money or the reward you receive for saving it.

  • If you borrow money, such as through a loan or credit card, interest is the extra amount you’ll pay on top of what you’ve borrowed.
  • If you save money, interest is what a bank or building society pays you for keeping your money with them.

Interest is usually shown as a percentage, known as the interest rate or APR (Annual Percentage Rate) for many credit products.

How does interest work on borrowing?

As a simplified example based on interest being charged once annually, if you borrowed £1,000 with an annual interest rate of 10%. You’d pay £100 in interest, meaning you’d owe £1,100 in total before considering repayments or any other fees.

However, most loans and credit cards calculate interest daily or monthly, so the amount you pay can vary depending on:

  • How much you owe
  • The interest rate
  • How long it takes you to repay the debt
  • Whether you make your payments on time

The longer you take to repay a debt, the more interest you’re likely to pay overall.

Simple interest vs compound interest

Not all interest works the same.

Simple interest is calculated only on the original amount you borrowed or saved.

Compound interest is calculated on both the original amount and any interest that’s already been added. This means interest can build up more quickly over time.

For savings, compound interest can help your money grow faster. For debt, compound interest can increase what you owe if balances are left unpaid.

Why does interest matter?

Even a small difference in interest rates can have a significant impact on your finances over time. A lower interest rate for borrowing could save you hundreds over the lifetime of the loan, but a savings account with a high interest rate can help your savings grow more quickly over time.

Credit cards usually have higher interest rates than other forms of borrowing, if you pay your balance in full every month, you can usually avoid paying interest but this does depend on whether you’ve paid in full by the due date and may not apply to cash withdrawals, balance transfers, or promotional/fee-bearing transactions.

If you only make the minimum payment, interest will continue to build on the remaining balance, which will then take longer to clear debt and cost you more overall.

What is APR?

When comparing loans or credit cards, you’ll often see the APR (Annual Percentage Rate). This includes the product’s interest rate, along with most compulsory charges and fees.

APR will give you a better idea of the total cost of borrowing and is the figure you should concentrate on when comparing products.

Can interest rates change?

Yes, some borrowing has a fixed interest rate that stays the same throughout the term of the agreement you’ve made. Other products have a variable interest rate, which can rise or fall depending on market conditions or the lender’s terms. You’ll see this commonly with variable mortgage terms.

Tips for managing interest

  • Compare interest rates before borrowing.
  • Pay more than the minimum repayment whenever you can.
  • Clear high-interest debts first if possible.
  • Check whether you could switch to a lower-interest product.
  • Review your savings regularly to make sure you’re earning a competitive rate.

If you’re struggling with managing your repayments

If you’re worried that interest is making your debts harder to manage, our advisers are here to provide you with guidance and support in a confidential, non-judgemental way.

If you’d like to explore your options or find out what support may be available to you, please get in touch here:

Get free debt advice online or call 0800 316 1833 to speak to one of our experts.

PayPlan’s advice is free, but some solutions may involve fees.