World 8 · Debt & borrowing · Lesson 2 of 10

Interest: simple, compound and APR

Interest is the price of borrowing. How it is calculated decides how fast a debt grows.

8 min read · Level: Foundation · Free — no account needed to read

The idea

Interest is the price of borrowing money — or the reward for lending it. It is usually expressed as a percentage of the amount borrowed, called the principal, per year. Simple interest is charged only on the principal: borrowing 1,000 at 10% simple interest for a year costs 100.

Compound interest is charged on the principal plus any interest already added. On a debt, that means interest on interest, which is why unpaid balances can grow surprisingly fast. A card balance of 1,000 at 24% a year, compounding monthly and never paid, grows to roughly 1,270 after one year and roughly 2,000 after three. The same force works in your favour on savings — it is simply working against you on debt.

APR — the annual percentage rate — tries to express the whole yearly cost of borrowing, including some fees, as one number, so that different loans can be compared. Two loans with the same monthly payment can have very different APRs and very different total costs.

Why it matters

Interest decides how much debt really costs and how fast it grows. Understanding it is the key to comparing loans and prioritising repayments.

A real example

The situation

Aisha wants a new phone and the shop offers to spread payments over two years with a low monthly amount. It seems very affordable.

What happened

She asks for the total she would repay and finds it is far more than the phone’s price. She buys a slightly older model outright with money saved over three months.

The takeaway

Asking for the total cost, not the monthly one, revealed what the interest was really doing.

How people actually behave

People find it hard to picture compounding, so they underestimate how fast debts grow — and how slowly they shrink when only small payments are made.

Common mistakes

• Comparing loans by monthly payment rather than APR and total cost.
• Ignoring interest on balances you plan to “pay soon”.
• Forgetting that fees and late charges add to the true cost.

Questions to think about

• Do you know the interest rate on every debt you have?
• Which of your debts is growing the fastest?

Try it: Find the real cost

1. For one debt or offer, find the APR and the total amount you would repay.
2. Subtract the amount borrowed to see the total cost of borrowing.
3. Compare it with at least one alternative, including saving first.

Words in this lesson

• Interest — The price of borrowing money, or the reward for lending or saving it, usually a percentage per year.
• Simple interest — Interest charged only on the original amount, not on interest already added.
• Compound interest — Interest charged or earned on both the original amount and the interest already added — interest on interest.
• APR (annual percentage rate) — The yearly cost of borrowing expressed as a percentage, including interest and some fees, so different loans can be compared.
• Principal — The original amount borrowed or invested, before interest.