When you hear the word “interest” in a financial context, what comes to mind? Credit card interest? Mortgage interest? Paying interest is certainly a reality for many, and knowing your interest rates is an important part of any plan to pay off debt. However, interest isn’t necessarily bad; the other side to interest is earning it.
What is interest?
At its most basic level, we usually think of interest as a fee paid to a lender for the privilege of borrowing money. However, there are additional meanings that can benefit you, including:
1. Ownership in a particular asset—including your own business.
2. A return received on an investment.
The truth is that interest is neither good nor evil. Like so many other terms you come across in personal finance, interest is a concept that can be advantageous or not, depending on how you make use of it.
The bad: Paying interest
Interest gets a bad rap because so many people have negative experiences with paying interest. Commonly, someone will carry a credit card balance and pay an annual percentage rate (APR) of anywhere between 11.99 percent and 29.99 percent. There are plenty of people who look at the interest they pay for homes and cars and on their credit cards and tote up what they could do with the money if it weren’t going into someone else’s pocket.
Paying interest represents a drain on your resources. When you pay interest, whether the debt in question is good or bad, you’re paying an outside organization for the privilege of using its money. Sometimes you can get a benefit on your taxes for paying student loan interest or mortgage interest, but that’s not the case with credit card debt. Essentially, the only real benefit from paying interest is the credit you are granted. In some cases, that access to capital can be justified, but only you can determine whether the price of interest is worth paying.
Even if you decide the interest is worth paying, you can maximize your financial resources if you pay off your debt as quickly as possible. The drain on your resources will stop, and you can begin using the money for your own benefit.
The good: Earning interest
There is a benefit in using credit to extend your buying power, get an education, or buy a home for your family, but there are also ways to earn interest. When you earn interest, your money works on your behalf. You earn an income at your job; interest is the way your money earns more money.
Some of the ways you can earn interest include:
Lending money to governments and businesses by buying bonds.
Investing in individual equities or in funds (including retirement account contributions).
Keeping your cash in an interest-bearing account, such as a savings account, CD account, rewards checking account. or money market account. (Keep an eye on minimum balances. You don’t want to spend all the interest you earn on bank fees.)
Starting a business that provides you with income and/or other returns.
Keep in mind, though, that even the good side of interest comes with risks. While cash products and many of the best-rated bonds aren’t likely to result in losses, you can lose money in investments and lending, as well as when you start a business. It’s important to measure your risk and attempt to earn interest prudently.
Interest itself is neither good nor evil. Its presence in your financial life, though, makes a difference. Even if you pay your credit card bill in full every month, you’ll likely have to pay interest at some point in your life for a car loan, student loan, or mortgage.
The way to make sure you get the best interest rates is by having a strong credit score. If you pay higher interest rates, you’re less likely to prosper. If you’re working to pay off debt and start earning interest, on the other hand, then there is a good chance that you are on the road to financial freedom.
Miranda Marquit is a freelance journalist specializing in financial topics. Read more of her writing on Huffington Post, Wise Bread, AllBusiness, and at her website, Planting Money Seeds. Follow her on Twitter: @MMarquit