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How debt works · Lesson 2 of 10

How Interest Makes Debt Grow: Amount, Rate and Time

Learn the three things that decide what a debt costs, how interest grows on itself, and why paying more each month is your strongest lever.

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THE WRITTEN LESSONFollow along at your pace

Every debt has a price, and interest is how that price is charged. In this lesson you will see the three things that set the price, how interest grows on itself, and the one thing you can change quickly: how much you pay each month.

Three dials

Think of every debt as having three dials. The first is the amount you owe. The second is the interest rate. The third is the time you take to pay it back. Turn any dial up, and the total cost goes up. Turn it down, and the cost falls.

Three round dials labeled Amount owed, Interest rate and Time, each with a minus and a plus end. Below them a bar labeled Total cost reads It falls, in green.(opens the full-size picture)
Amount owed, interest rate and time: turn them down and the cost falls.

Interest on interest

Interest is not charged just once. It is added again and again, often every day, and the next day’s interest is worked out on the bigger balance. So interest starts to earn interest of its own.

For example, leave $1,000 at 20% for a year. Simple interest, charged only on the original amount, would be $200. Charged daily, it is about $220. The rate never changed. The difference comes from interest being added to the balance every day.

A snowball rolling down a hill and growing, labeled Interest on interest, above seven day cards that each add a coin and plus interest. Two bars for 1,000 dollars at 20 percent for a year: Simple, 200 dollars, and Daily, about 220 dollars, in red.(opens the full-size picture)
The same rate costs more when interest is added every day.

Compare the APR

To compare debts, look at the APR, the yearly rate that includes most fees. Compare APR with APR, not a monthly payment with a monthly payment. A low monthly payment can hide a high rate, or a long time.

Daily charges are easy to miss because no single day looks expensive. On a card at 24%, every $1,000 you owe costs about 66 cents a day.

Two cards labeled APR, one showing 12 percent and one showing 24 percent with a red circle around it. Two crossed-out Monthly payment tags sit below, and a calendar day beside the text about 66 cents a day for every 1,000 dollars you owe.(opens the full-size picture)
Compare APR with APR. At 24%, $1,000 costs about 66 cents a day.

The lever you control

The rate and the amount are hard to change quickly. The payment is yours. Take $2,000 at 18%:

  • Pay $60 a month, and it takes about 4 years and costs around $790 in interest.
  • Pay $160 a month, and it is gone in about 14 months, for around $230 in interest.

Same debt, same rate. Only the payment changed.

Two bars for 2,000 dollars at 18 percent. At 60 dollars a month, a long bar with a red interest slice: about 4 years and about 790 dollars interest. At 160 dollars a month, a short bar with a small red slice and a check mark: about 14 months and about 230 dollars interest.(opens the full-size picture)
A bigger monthly payment cuts both the time and the interest.

Early payments are mostly interest

On a long loan, the first payments go mostly on interest, and only a little reduces what you owe. A longer term means a smaller monthly payment, but more interest overall. Shorter is almost always cheaper.

Ten payment bars from first to last, each split into red interest on top and green debt paid off at the bottom. The green part grows from small to large. Two boxes below: Longer term, smaller payment, more interest, in red, and Shorter term, less interest overall, in green.(opens the full-size picture)
Early on, most of each payment is red interest.

These are simple examples with round numbers. Real loans add fees, and rules and rates differ by country and lender. Check your own statements.

YOUR TURN

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Read the full lesson script

Welcome back. In this lesson, you'll see how interest makes a debt grow, the three things that decide its cost, and the one lever you control most.

Every debt has three dials. The amount you owe. The interest rate. And the time you take to pay it back. Turn any of them up, and the total cost goes up. Turn them down, and it falls.

Interest isn't charged just once. It's added again and again, often every day, and the next day's interest is worked out on the bigger balance. Leave a thousand dollars at twenty percent for a year, and simple interest would be two hundred dollars. Charged daily, it's about two hundred and twenty.

To compare debts, look at the APR, the yearly rate that includes most fees. Compare APR with APR, not a monthly payment with a monthly payment. A card at twenty-four percent costs about sixty-six cents a day for every thousand dollars you owe.

The rate and the amount are hard to change quickly. But the payment is yours. Take two thousand dollars at eighteen percent. Pay sixty dollars a month, and it takes about four years and costs around seven hundred and ninety in interest. Pay a hundred and sixty, and it's gone in about fourteen months, for around two hundred and thirty.

On a long loan, the first payments go mostly on interest, and only a little reduces what you owe. A longer term means a smaller monthly payment, but more interest overall. Shorter is almost always cheaper.

So remember: the amount, the rate and the time decide what a debt costs. Interest grows on itself, often daily. And paying more each month is the strongest lever you control. Before the next lesson, find the interest rate, the APR, on your biggest debt. Next, you'll see the trap of minimum payments.