Budgeting · Financial Products

Good Interest and Bad Interest

This article is dedicated to all the good interest out there and how it can benefit you!urur

We can all think of ‘bad’ interest examples:

–              Credit card interest

–              Mortgage interest

–              Interest due on purchases

In short, bad interest costs us money.

But there is also a good type of interest.

What is interest?

Interest is money received from loaning money to others. Note this definition can benefit you or hinder you, depending if you are the one loaning the money or paying the interest.

How the interest cycle works – a very, VERY simple example

I earn interest from the bank by lending my savings to them (banks have ‘savings accounts’ for this specific purpose). They use these savings accounts to maintain a positive cash flow. Traditionally, this means they use the money to provide loans to other people who in turn, pay interest to the bank. And then, the bank pays interest to me. And then the cycle continues…

What is good interest?

Good interest is what I call interest that improves your net financial position.

I know this is very specific but I feel it needs to be.

I am not referring to good interest as ‘money received’ because it may not benefit you in the long run.

Good interest has to be money that makes a positive impact to your wallet after all activities are complete.

For example: ABC Bank has a ‘savings account’ available. They pay 5% interest on deposits every month. ABC Bank also has a $10 per month fee (which is written in tiny text in the 100 paged terms and conditions leaflet).

So, you deposit $10 at the start of the month. At the end of that month ABC bank pays you $0.50 in interest. “Yay! Money!” you say – WRONG! ABC Bank then deducts their account fee:

Balance                                10.00

+ Interest                              0.50

                                                10.50

– Account Fee                     10.00

Balance                                $0.50

So, in this instance, earning interest didn’t benefit you in the long run, as you lost your interest AND 95% of your principal! So the whole effort negatively impacted your net worth.

So, this is not good interest.

What is the lesson here?

 Interest does not just happen in isolation!

You must look at all of the components of an investment before you invest!

Even if it is just to open one measly savings account.

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