Compound interest is the bane of existence for students, former and current; it’s behind the debt snowball that just keeps getting bigger and bigger. It’s the reason why the principal amount of debt is difficult to pay off. However, for those interested in personal finance, compound interest is where students can take back their power, and this is how.
Understanding What Is Behind Accruing Interest Is the First Step
Many students fail to grasp what interest rates really mean. For example, if you have a $1,000 loan with a 5% annual interest rate, by the end of the first year, you owe $1,050. If you don’t pay off that interest, it gets added to the principal, and the next year, you owe interest on $1,050, not just $1,000.
Now imagine if the interest rate was 15%. By the end of the first year, you would owe $1,150. In the second year, with the same interest rate, your debt would grow to $1,322.50 ($1,150 + 15% of $1,150). By the third year, it would increase to $1,519.88 ($1,322.50 + 15% of $1,322.50).
Over time, this compounding effect can lead to a much larger debt than you initially borrowed, underscoring the importance of understanding and effectively managing compound interest.
College Students Should Always Know Their Financial Numbers When Dealing with Interest Rates
Once you have a good understanding of the accumulation process of interest rates and know your numbers, no matter how scary it is, you can learn how to take advantage of interest rates.
For example, when interest rates are low, people tend to borrow more money because it is cheaper to borrow. However, it’s important to understand that interest rates do and will change. Knowing that you can get a loan for 5% instead of 15% is a way better deal, saving you significant money over time and allowing you to make more informed financial decisions.
Take fictional college student Daniel, for instance. He initially considers a loan with a 15% interest rate but realizes he can’t afford the payments, opting instead for financial assistance like food stamps, food banks, free public transportation card from his college, and is open to selling items or taking on temporary work.
A year later, when interest rates drop to 5%, Daniel reassesses and finds he can comfortably afford to take out the loan and make payments that will go towards both the interest and principal.
Maximize Interest Rates With High Yield Saving Account’s
As college students when we come across financial help and are able to put some things back, it’s important to have the right accounts that have a high interest rate compared to others. This is called a high-yield savings account.
For example, my local credit union that I use only gives me $0.08 each month for a $2,000 savings; however, my high-yield savings account with another bank gives me about $5 each month with less money because it has a 4.25% interest rate versus my credit union.
Even though I don’t know the exact interest rate for my credit union, you can tell it’s not much for a couple of thousand dollars.
To find a high-yield savings account, you can start by doing some research online. Look for well-reviewed financial institutions and compare their interest rates, fees, and account features. Capital One is a popular option known for offering competitive interest rates on their high-yield savings accounts.
Other notable banks include Ally Bank, Marcus by Goldman Sachs, and Discover Bank, which also offer attractive rates and user-friendly account management. By exploring these options, you can find the best fit for your financial needs and ensure your savings grow more efficiently.
Minimize Your Interest Rate Burden With Loans
As college students, especially if you’re a broke college student, you don’t make much and you don’t have much to put back. Just putting back something, and knowing that you have an interest rate working for you, can be psychologically beneficial because you know in the back of your mind that something is being made with your money instead of being taken from you like interest rates on student loans.
Even though some students don’t have a choice and a loan is their only option, even in a high interest rate environment, understanding what they’re paying and when that loan goes into effect is crucial. Some loans accrue interest after graduation, while others accrue during school. Understanding the terms that you sign is really important to taking control of your financial health.
Even if you can’t do anything about the loans right now or the interest rates, knowing the details helps. For example, if you need to take out $20,000 but you’re offered $50,000, don’t take out the $50,000. Only take out what you need and that will help you way more because the interest rate will already be crazy.
Can you imagine a 15% interest rate on $20,000 versus $50,000? Even though it’s high on both, I’d rather take the $20,000 with that rate than the $50,000.
To put this into perspective, let’s look at the numbers. With a 15% interest rate, if you borrow $20,000, by the end of the first year, you will owe $23,000 ($20,000 principal + $3,000 interest).
By the end of the second year, you would owe $26,450 ($23,000 principal + $3,450 interest). In contrast, if you borrow $50,000 at the same 15% interest rate, by the end of the first year, you will owe $57,500 ($50,000 principal + $7,500 interest). By the end of the second year, you would owe $66,125 ($57,500 principal + $8,625 interest).
The difference is substantial. After two years, the $20,000 loan would have accrued $6,450 in interest, while the $50,000 loan would have accrued $16,125 in interest. Borrowing only what you need minimizes the interest burden and makes managing your debt more feasible.
Wrapping Up: Making Compound Interest Work for You
Understanding compound interest and how it impacts your finances is crucial for any college student. We covered how compound interest can work against you, especially with high-interest loans, but also how it can work in your favor with the right savings accounts.
By carefully managing your borrowing and taking advantage of high-yield savings accounts, you can significantly improve your financial situation. We also discussed the importance of understanding loan terms and only borrowing what you truly need. Remember, with the right strategies, you can make compound interest an ally rather than an adversary in your financial journey.
The Broke College Student 
Leave a comment