Interest is the cost of borrowing money, and is a percentage of the borrowed amount, usually expressed an an annual percentage rate (APR). Interest applies both to consumers when they borrow money from banks in the form of car and home loans, and to banks when they borrow money from consumers in the form of savings accounts.

There are two main types of interest: simple and compound. For simple interest, the amount every year is based on the borrowed amount, which is called the principal. Car and home loans use simple interest. For compound interest, the amount every year is based on both the principal and accumulated interest. Savings accounts use compound interest, which will be discussed in a later section.

To calculate simple interest from a principal, APR, and number of years, divide the APR by 100 to get a decimal, multiply that by the principal to get the yearly amount, and multiply that by the number of years to get the total amount.

For example, you borrow $100 with 10% interest, and pay it back in 3 years. To calculate the interest amount, do the following:

principal = $100
percent   = 10
decimal   = 10 ÷ 100 = 0.1
yearly    = $100 × 0.1 = $10
years     = 3
total     = $10 × 3 = $30

Interest is usually paid in monthly payments. If just the interest amount, and not a portion of the principal is paid every month, it is called an interest-only loan. To calculate the monthly payment, divide the yearly amount by 12.

In reality, for car and home loans, both a portion of the principal and the interest amount are paid every month. This means the loan is slowly paid back each month, which also reduces the interest each month. This is called an amortizing loan, but that's beyond the scope of this section. For the exercises below, treat all loans as interest-only loans.