When you take out a loan or put money in an investment, is one type of interest better than the other? Do you have a choice? You don't usually get to pick the type of interest you will receive with a loan or an investment. Always identify and understand the type of interest being charged on any loan or investment contract that is offered you. All lenders and creditors must by law disclose to the borrower the terms of a loan and the total costs.
Since you have seen how to calculate both simple and compound interest, you may have noticed that you will either pay more or earn more on a loan or an investment that has compounded interest. Always keep in mind that it is better to invest and earn money with compound interest, and it is better to borrow money or take out loans with simple interest. Read through the examples below describing where you may encounter simple interest or compound interest.
Simple Interest
Simple interest is mostly used for loans. Some examples of where you may encounter simple interest on loans or investments are:
- auto loan
- personal loan
- certificate of deposit investment
- mortgage loan
Compound Interest
Some examples of where you may encounter compound interest are:
- bank accounts including savings or checking
- investment accounts
- credit cards
Level Up!
Now that you have a better idea of compound and simple interest, use your knowledge to answer the mismatch activity below. Read the action described and decide if simple interest or compound interest would be better.
1. Tom takes out a mortgage to purchase a new house.
Simple interest is more beneficial on loans since you will pay less in interest than you would with compound interest.
Simple interest is more beneficial on loans since you will pay less in interest than you would with compound interest.
2. Erica opens a 401(k) retirement plan with her employer.
Compound interest is more beneficial on investments because you will earn more money than you would with simple interest.
Compound interest is more beneficial on investments because you will earn more money than you would with simple interest.
3. Caleb has a credit card that currently has a balance of $3,000.
Even though most credit cards use compound interest, simple interest means that you would pay less in interest on any bill that you do not pay in full.
Even though most credit cards use compound interest, simple interest means that you would pay less in interest on any bill that you do not pay in full.
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