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WalletPrep worksheet · Money basics

How does interest work?

Name ____________________ Date __________

Key ideas

  1. Interest is a yearly price, shown as a percent. 4% a year on $1,000 is about $40. The bigger the balance or the rate, the more interest.
  2. APR is the rate, APY includes compounding. A 24% APR, charged 2% a month, costs about 26.82% over a year if nothing is paid.
  3. The same math helps savings and hurts debt. In the example, $1,000 in savings earns $41 in a year. $1,000 left on a card grows by $268.

Vocabulary

Compound interest
Interest earned on both your original money and the interest it already earned, so growth speeds up over time.
APR
Annual percentage rate: the yearly cost of borrowing money, shown as a percentage. It is the number to compare on cards and loans.
APY
Annual percentage yield: the yearly return on savings, including the effect of compounding. Use it to compare savings accounts.

Work it out

Priya has $1,000 in savings at 4% a year and owes $1,000 on a card at 24% APR. Both compound monthly. She adds nothing and pays nothing for a year.

  1. Savings at 4% a year
  2. Interest earned, 12 months
  3. Savings after a year
  4. Card balance at 24% APR
  5. Interest charged, 12 months
  6. Owed after a year
  7. Simple interest at 24%

Check yourself

  1. Your card has an 18% APR. What is the monthly rate?

    • A. 1.5%
    • B. 18%
    • C. 0.18%
    • D. 3%

  2. Which number should you use to compare two savings accounts?

    • A. The APR
    • B. The APY
    • C. The routing number

  3. $200 earns 5% compound interest once a year. What is the balance after 2 years?

    • A. $210
    • B. $220
    • C. $220.50
    • D. $205

Your turn

Find the APY on your savings account and the APR on each card or loan you have. Write them side by side. The highest APR is the debt costing you the most each month.

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Answer key

How does interest work?

Work it out

  1. Savings at 4% a year$1,000
  2. Interest earned, 12 months$41
  3. Savings after a year= $1,041
  4. Card balance at 24% APR$1,000
  5. Interest charged, 12 months$268
  6. Owed after a year= $1,268
  7. Simple interest at 24%$240
  1. Savings: 4% ÷ 12 is about 0.33% a month, added each month. After 12 months, $1,000 grows to $1,041.
  2. Card: 24% ÷ 12 = 2% a month on a growing balance. After 12 months, $1,000 grows to $1,268.
  3. Simple interest would be $1,000 × 24% = $240. Compounding adds $28 more, so the real yearly cost is about 26.82%.

Check yourself

  1. A. 1.5% 18% ÷ 12 = 1.5% a month. Card interest is charged monthly at one twelfth of the APR.
  2. B. The APY APY counts compounding, so it shows what each account really pays over a year.
  3. C. $220.50 Year 1: $200 + $10 = $210. Year 2: $210 + $10.50 = $220.50. The extra 50 cents is interest on interest.