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Interest Explained: Your Comprehensive Guide to the Concept of ‘Interest’

If you need to borrow money for whatever purpose, you have to be prepared to pay interest. It’s pretty simple, right? Think of it as a ‘service fee’ for getting instant money at a time of need. This means you have to pay back not only the full amount you borrowed, but also any interest that may have attached to it. Interest rates differ for every lender, but there’s usually a standard rate required by the Bangko Sentral ng Pilipinas. 

Two Kinds of Interest

1. Simple interest

               As the name suggests, this kind of interest is computed simply. You just have to multiply the amount you borrowed to the interest rate applied by your lender to get the total amount of money you have to pay back.

2. Compounded interest

               This one is a little bit trickier. For this type, it’s not just the principal amount that generates interest. Even interest charges from previous months or years will be charged interest of their own! In other words, it is charging “interest on interest.”

Pro tip: avoid entering into compounded interest agreements as much as you can. If your lender offers you this, try to negotiate. A better alternative would be simple interest loans as discussed above, or fixed interest loans, which ensures that your interest rate will not change for the duration of your repayment. 

Another pro-tip would be to consolidate all your loans to the same financial institution. If you have several small debts, you might find it difficult to keep track on due dates and various interest rates. So you might want to try loaning out a huge amount that will pay off all your smaller loans. This way, you only owe one institution and repayment will be much easier. 

What is interest payment accumulation?

               If you have no choice but to go for a compounded interest loan, take note that your monthly repayments will be bigger than you originally calculated. That’s because lenders will ask you to pay a portion of the interest from your very first payment until you have fully paid the principal amount and the total interest that have attached to it. This is what they call “interest payment accumulation.”

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