when you leave money in your savings account your account is credited interest this is because the bank uses your money and loans it out to other clients resulting in you earning interest revenue 
the amount of interest a person must pay is often tied to their creditworthiness the length of the loan or the nature of the loan all else being equal interest and interest rates are higher when there is greater risk as the lender faces a greater risk in the borrower not being able to make their payments the lender may charge more interest to incentivize them to make the loan apr includes the loan s interest rate as well as other charges such as origination fees closing costs or discount points history of interest ratesthis cost of borrowing money is considered commonplace today however the wide acceptability of interest became common only during the renaissance interest is an ancient practice however social norms from ancient middle eastern civilizations to medieval times regarded charging interest on loans as a kind of sin this was due in part because loans were made to people in need and there was no product other than money being made in the act of loaning assets with interest the moral dubiousness of charging interest on loans fell away during the renaissance people began borrowing money to grow businesses in an attempt to improve their own station growing markets and relative economic mobility made loans more common and made charging interest more acceptable it was during this time that money began to be considered a commodity and the opportunity cost of lending it was seen as worth charging for political philosophers in the 1700s and 1800s elucidated the economic theory behind charging interest rates for lent money authors included adam smith fr d ric bastiat and carl menger iran sudan and pakistan use interest free banking systems iran is completely interest free while sudan and pakistan have partial measures 1 with this lenders partner in profit and loss sharing instead of charging interest on the money they lend this trend in islamic banking refusing to take interest on loans became more common toward the end of the 20th century regardless of profit margins today interest rates can be applied to various financial products including mortgages credit cards car loans and personal loans interest rates started to fall in 2019 and were brought to near zero in 2020 formula and calculation for interestin its most basic form interest is calculated by multiplying the outstanding principal by the interest rate interest interest rate principal or balancethe more complex aspect of calculating interest is often determining the correct interest rate the interest rate is often expressed as a percentage and is usually designated as the apr however calculating the apr often does not reflect any effects of compounding instead the effective annual rate is used to express the actual rate of interest to be paid often an annual rate must be converted to calculate the applicable interest earned in a given period for example if a savings account is to pay 3 interest on the average balance the account may award 0 25 3 12 months each month the applicable interest rate is then multiplied against the outstanding amount of money related to the interest assessment for loans this is the outstanding principal balance for savings this is often the average balance of savings for a given period in either case the amount of interest assessed each period will likely change for loans borrowers will have likely made payments that reduce the principal balance resulting in lower interest for savers general activity including the addition of last month s interest often changes the applicable balance your credit score has the most impact on the interest rate you are offered when it comes to various loans and lines of credit simple interest vs compound interesttwo main types of interest can be applied to loans simple and compound simple interest is a set rate on the principal originally lent to the borrower that the borrower has to pay for the ability to use the money compound interest is interest on both the principal and the compounding interest paid on that loan the latter of the two types of interest is the most common for obvious reasons individuals attempting to earn interest prefer compound interest agreements this agreement results in interest being earned on interest and results in more total earnings savings accounts with banks often earn compound interest any prior interest earned on your savings is deposited into your account and this new balance is what earns interest in future periods on the other hand compound interest is extremely concerning for borrowers especially if their accrued compound interest is capitalized into their outstanding principal this means the borrower s monthly payment will actually increase due to now having a greater loan than what they started with common applications of interestthere s countless ways a person can charge or be charged interest below are some common examples of where interest may be earned by one party and paid by another a quick way to get a rough understanding of how long it will take for an interest bearing account to double is to use the so called rule of 72 simply divide the number 72 by the applicable interest rate at 4 interest for instance and you ll double your investment in around 18 years i e 72 4 advantages and disadvantages of paying interestimagine a situation where you absolutely need reliable transportation to get to work there is no public transit system you do not own a car work is far away and you can t afford to buy an entire car outright the largest advantage of paying interest is it is a relatively low expense compared to alternatives paying interest also means a payer is holding debt building their credit history and potentially effectively using leverage for example real estate developers often borrow money to construct and rent buildings if the rate of return on the building is greater than the interest rate they are charged the company is successfully using someone else s money to make money for themselves on the downside interest is a recurring cash expense payers are often contractually obligated to pay interest and monthly payments are typically applied to interest assessments before paying down the principal consumers may find interest assessments overwhelming in addition having too many loans and too high of monthly payments may restrict a borrower from being able to take out more credit may be the result of much needed capital relatively speaking it may be worth the small expense during emergencies 