Hi everyone, I am Liam. Today we are starting a deep dive into the world of borrowing. In Canada, we use credit for almost everything, from buying a coffee to buying a home. But to be smart with your money, you need to understand the engine that drives debt, which is interest.I am Maya. Interest is simply the price you pay to borrow money. If you borrow one hundred dollars and have to pay back one hundred and five dollars, that extra five dollars is the interest. It sounds simple, but the way that five dollars is calculated can change the total cost of your purchase by thousands of dollars over time.I am Chloe. Let us start with the most basic form, which is simple interest. Simple interest is calculated only on the principal, which is the original amount of money you borrowed. For example, if you borrow one thousand dollars at a simple interest rate of ten percent per year for three years, the math is very straightforward. You multiply the principal of one thousand by the rate of zero point one zero and the time of three years. That equals three hundred dollars. Every year, you are charged exactly one hundred dollars. At the end of three years, you pay back one thousand three hundred dollars. Simple interest is rare in modern banking, but it is often used for short term personal loans between friends or for specific types of bonds.And I am Noah. While simple interest is easy to understand, most of the financial world runs on something much more powerful and potentially dangerous: compound interest. Compound interest is interest calculated on the initial principal and also on the accumulated interest of previous periods. Think of it as interest on interest. Let us take that same one thousand dollars at ten percent for three years, but this time we will compound it annually. In the first year, you owe one hundred dollars in interest, bringing your total to one thousand one hundred dollars. But in the second year, the bank calculates ten percent of that new total. Ten percent of one thousand one hundred is one hundred and ten dollars. Now you owe one thousand two hundred and ten dollars. In the third year, they take ten percent of that. By the end, you owe one thousand three hundred and thirty-one dollars. That extra thirty-one dollars might not seem like much now, but over twenty years, the difference becomes massive.The real secret to understanding the cost of borrowing is the compounding period. This is how often the bank calculates the interest and adds it to your balance. The most common periods are annually, semi-annually, monthly, weekly, and even daily. The rule is simple: the more frequently interest is compounded, the more you will pay in total. If you have a five thousand dollar loan at twelve percent interest, compounding it once a year adds six hundred dollars in interest. But if that same loan is compounded monthly, the interest is calculated every thirty days on the new balance. By the end of the year, you owe six hundred and thirty-four dollars. That is thirty-four dollars extra just because of how the math was applied.Let us look at a very common Canadian example: credit cards. Most credit cards in Canada have an interest rate of around twenty percent. But here is the catch. They compound interest daily. This means every single day you carry a balance, the bank calculates interest and adds it to what you owe. If you have a two thousand dollar balance, the daily interest is small, but because it happens three hundred and sixty-five times a year, the cost grows exponentially. If you only make the minimum payment, you are barely covering the interest that was added that month, let alone the original principal. This is why it can take decades to pay off a credit card if you are not aggressive about it. The math of daily compounding is designed to keep you in debt for as long as possible.Now, let us compare the pros and cons of these different ways interest is calculated. The pro of simple interest is predictability and lower costs for the borrower. You always know exactly what you owe. The con is that it is hard to find this type of loan in the professional world. The pro of compound interest is mostly for the lender or the saver. If you are saving money, compound interest helps your wealth grow faster. But for a borrower, the con is that the cost can accelerate quickly. If you miss a payment and that interest is compounded, you are now paying interest on the money you were supposed to pay last month. It creates a snowball effect that is very hard to stop.It is also important to talk about the risks of different borrowing tools. In Canada, we have payday loans. These are short term loans that often have extremely high interest rates and compound very quickly, sometimes every week. A payday loan might charge fifteen dollars for every one hundred dollars borrowed for two weeks. If you calculate that as an annual percentage rate, it is over three hundred and ninety percent. This is a massive risk. If you cannot pay it back in two weeks, the interest compounds and you could end up owing double what you borrowed in just a few months. Compared to a standard personal loan from a bank at eight or ten percent, payday loans are incredibly dangerous. Always check the annual percentage rate before you sign anything.So, how do you use this information to your advantage? First, always ask how the interest is compounded. If you are comparing two loans with the same interest rate, choose the one that compounds less frequently. A loan that compounds annually is always cheaper than one that compounds monthly or daily. Second, understand the difference between the nominal interest rate and the effective interest rate. The nominal rate is what is advertised, like twelve percent. The effective rate is what you actually pay after compounding is factored in. In the case of our five thousand dollar loan, the nominal rate was twelve percent, but the effective rate was twelve point six eight percent because of monthly compounding. Always look for the effective rate to see the true cost.Another tip for your life is to avoid carrying a balance on high frequency compounding debt. Since credit cards compound daily, every day you wait to pay them off costs you money. Even paying half of your bill mid-month can reduce the amount of interest that gets compounded daily. The math shows that the earlier you pay, the less interest can accumulate. This is a simple way to use the bank’s own math against them. If you have extra cash, put it toward the debt with the highest compounding frequency first. This is called the avalanche method, and it is the fastest way to save money on interest charges.Let us recap what we have learned about the mechanics of interest. Simple interest is calculated only on the principal. Compound interest is calculated on the principal plus any interest that has already been added. The compounding period is the frequency of these calculations, and more frequency means a higher total cost. Whether you are using a credit card, a personal loan, or looking at a payday lender, the way interest is calculated is the biggest factor in how much that item will actually cost you in the end. Being able to run these numbers makes you a much more powerful consumer.In the next video, we will look at how the length of the loan and your down payment change these numbers even further. But for now, remember that interest is a cost. Treat it like any other price tag. If you do not like the price the compounding math is giving you, look for a different way to pay. You have the mathematical tools to see exactly how much extra you are paying for the convenience of borrowing. Use those tools every time you see a percentage sign. Understanding the difference between simple and compound interest is the foundation of every good financial decision you will ever make.As you continue through this course, keep these formulas in mind. When we talk about mortgages or car loans later, we will be using compound interest math every single time. It is the language of the Canadian financial system. The more comfortable you are with the logic of compounding, the easier it will be to manage larger debts like a home or an education. You are building a solid foundation today that will save you a fortune in the future. Great job sticking with the math and seeing the big picture. We are proud of the work you are doing.Think about a time you borrowed money or saw a credit card offer. Now that you know about daily compounding, does that offer look different to you? It should. Knowledge is your best defense against high costs. Keep practicing these calculations and keep asking questions about the fine print. You are becoming a master of your own financial destiny, one calculation at a time. We will see you in the next section where we put these interest types into action with real world purchases. See you then!
