What Is Interest?

Ages 3-5 Simple Explanation

You know how if you do something nice for someone, they might do something nice for you back? Interest is kind of like that, but with money. When you let the bank keep your money, the bank says 'thank you' by giving you a little extra money. That extra money is called interest.

Imagine you put $10 in a piggy bank at the real bank. After a while, the bank might add a few extra cents to your money as a thank-you gift. Now you have more money than you started with, even though you didn't do anything! That's how interest works when you save.

But interest works the other way too. If someone borrows money, they have to give back more than they took. It's like if you borrowed your friend's toy and returned it with a little thank-you gift. The extra part is the interest.

The cool thing about interest is that it helps your money grow if you save it. The longer you leave your money in the bank, the more extra money the bank gives you. It's like planting a seed and watching it slowly grow into a bigger plant!

Ages 6-8 More Detail

Interest is extra money that gets added when you save money or borrowed money gets paid back. There are two sides to interest: the good side (when you earn it) and the not-so-good side (when you owe it). Let's look at both.

When you put money in a savings account at a bank, the bank pays you interest. If you save $100 and the bank pays 3% interest per year, you'll earn $3 by the end of the year — so you'd have $103 without doing a thing! The bank pays you because they use your money to make loans to other people.

When someone borrows money — like a car loan or a mortgage for a house — they have to pay interest to the bank. If they borrow $100 and the interest rate is 5%, they have to pay back $105. That extra $5 is the price of borrowing someone else's money.

This is why saving money is such a smart idea. When your money sits in a bank earning interest, it grows all by itself. And the longer you leave it there, the more it grows. It's slow at first, but over many years, the growth speeds up because you start earning interest on your interest!

The percentage that gets charged or paid is called the interest rate. A higher interest rate means more money gets added. When you're saving, you want a high interest rate (more free money for you!). When you're borrowing, you want a low interest rate (less extra money you have to pay back).

Ages 9-12 Full Explanation

Interest is the cost of using someone else's money, or the reward you get for letting someone use yours. It's one of the most important concepts in all of finance, and understanding it can literally make you richer over your lifetime. Interest is expressed as a percentage, called the interest rate.

When you deposit money in a savings account, the bank pays you interest. Why? Because the bank doesn't just store your money in a vault — they lend it to other people and businesses. The interest they pay you is your share of the profit. If you have $1,000 in an account earning 4% interest, you'd earn $40 in the first year.

On the flip side, when you borrow money, you pay interest to the lender. A car loan at 6% interest means you'll pay back the original amount plus 6% per year. Credit cards are especially expensive — many charge 20% or more. That's why carrying a credit card balance can become a financial trap really fast.

The real magic of interest is something called compound interest — earning interest on your interest. Here's how it works: if you save $1,000 at 5% interest, after year one you have $1,050. In year two, you earn 5% on $1,050 (not just the original $1,000), giving you $1,102.50. The growth gets faster every year. Over 30 years, that $1,000 would grow to over $4,300 without you adding a single dollar.

Albert Einstein reportedly called compound interest the 'eighth wonder of the world.' Whether he actually said that or not, the point stands: compound interest is incredibly powerful. But it works both ways. When you're saving, it's your best friend. When you're in debt, it's your worst enemy — because the amount you owe keeps growing on top of itself too.

This is why starting to save early matters so much, even if it's just a small amount. A 12-year-old who saves $500 and earns 7% interest per year would have over $10,000 by age 65 — from just that one $500 deposit. But a 40-year-old who saves the same $500 at the same rate would have only about $2,800 by age 65. Time is the secret ingredient that makes interest really powerful.