First of all, some basic terms.
- Principal. Principal is the amount of money you originally deposited into a savings or checking account.
- Interest. Interest is the money you are paid for lending (i.e., depositing) money to a bank. For most people, interest accumulates through a savings or checking account.
Now, let's look at the two types of interest: simple and compound.
- Simple. Simple interest is the money paid to you on the principal alone of your deposited funds.
- Compound. Compound interest is the money paid to you on the principal plus any interest you may have earned with your savings account over a designated period of time. Some interest is compounded monthly, some yearly, or with bookies, compounded weekly. Compounding is based on a "simple math formula" you can check out here. On the other hand, compound interest can be what you pay back to the government or a private lender on your original student loan amount, plus whatever interest that has compounded weekly, monthly, or yearly.
Finally, knowing the difference between these two types of interest can save you, or even earn you, money. Not knowing the difference can cost you a lot of money--especially with credit card debt.
- Save money. When borrowing student loans, you accumulate compound interest. Lots of it, in fact, over the duration of the loan. Credit cards are even worse for compound interest since they charge higher interest rates and encourage small, minimum payments. This compound interest is added to your principal (or original borrowed amount), where it continues to compound and increase your existing debt and lasting anxiety.
- Therefore, if you pay your interest on your student loan while a student, your will not suffer from compound interest, thereby saving you money.
- When paying back the overall loan (or credit card bill), you should increase your payments above the minimum to decrease the total principal, so you will have less compound interest. You will also save money and decrease the amount of time to pay off the loan.
- Earn money. You can also earn more money by taking advantage of compound interest.
- Make regular deposits to your savings or investments. Use automatic banking features to have money deposited to an interest bearing or investment account.
- You can also cut out unnecessary expenses, like eating out, and add those savings to an interest bearing account and watch it increase over the years.