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How interest works

13 September 2019 | 4 min read

You might have come across the word ‘interest’ when browsing things like savings accounts, credit cards, personal loans and home loans. But what is it? When do you earn it? When do you pay it? 

 

What is interest?

Interest is the money you pay OR earn on the balance of funds that is owed OR in your savings. The amount of interest you pay or earn is determined by something called an interest rate.

For example, your friend lends you $200 with a 5% interest rate per year.
5% of any amount is 0.05 x the total amount. For your loan, it is 0.05 x 200 = $10

  • The loan balance is $200

  • The interest paid is $10

  • The interest rate is 5%

In 12 months’ time, you will need to pay them back $210.

Compounding interest

Compounding interest is when you earn interest on your interest.

You have a savings account with $100 in it. You earn 1% interest each year, calculated at the end of each year.

At the end of year one, you earn $1 in interest. You now have $101.

But at the end of year two, you will earn 1% interest on your $101, so you now have $102.01 because you earned $1.01.

Savings accounts

When you open a savings account, you earn interest on the money inside that account.

Sometimes there are rules that must be followed to be eligible to earn that interest like not being able to transfer the money out or needing to complete a certain number of transactions.

On our EasySaver account, we offer 0.75% interest and it’s calculated daily but paid monthly.

This means that each day, we’ll record what 0.75% interest is and divide it by 365 (or 366 for a leap year) and add it up at the end of each month to then pay you interest.

Home loan interest

The interest rate on your home loan is affected by several factors but essentially, it’s kind of the opposite of the savings account. In most circumstances, it’s calculated daily and paid monthly but it becomes what you owe on top of your loan amount.

If you have a $500,000 outstanding loan amount and your interest rate is 4%, your interest is calculated for the day and then charged to you monthly.

  • 4% of any amount is 0.04 x the whole amount.

  • ($500,000 x 0.04) divided by 365 (days) = $54.79

  • If you hadn’t paid any of your loan in a 30-day month, your interest repayment for one 30-day month would be $54.79 x 30 = $1643.70

However, you may also have an offset account. An offset account is used like an everyday transaction account but it means that the money in there is counted toward your home loan.

Your offset account may have your salary and other savings in it. The money in your offset account ‘reduces’ your overall home loan. If you’re looking to reduce your interest payments, you may want to consider an offset account.

Credit card interest

Credit card interest, like home loan interest, is calculated daily and charged to you monthly.

But this depends if you’re making a ‘purchase’ or a ‘cash advance’.

For purchases, there’s something we call ‘an interest-free period’. At Bendigo Bank, we usually offer up to 55-day interest free period on purchases. This means if you pay your credit card balance by the due date, you won’t incur any interest charges.

If you don’t pay your credit card balance, you will begin incurring interest. We charge interest from the statement date rather than when you made the purchase. This means we only charge interest on the total outstanding amount (not each purchase), so if you’ve made a partial payment, you will only pay interest on the rest of the outstanding amount.

For example, if you spend a total of $300 on different purchases on your credit card, but only pay $100 off by the due date, you will be paying interest on the other $200. The interest on the $200 would be calculated daily and charged monthly.

For cash advances, interest accrues straight away. This means you will be charged interest on unpaid cash advances from the date that they are charged to the account until you’re able to pay that money back.

All interest-ed out? If you want to talk it out with one of our experts, call us here or take a look at our savings accounts, credit cards, home loans, personal loans and all the relevant information.

Note: This article contains general advice only. Readers should seek a trusted professional’s advice on financial matters.

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Bendigo and Adelaide Bank Limited, ABN 11 068 049 178 AFSL / Australian Credit Licence 237879. Any advice provided on this website is of a general nature only and does not take into account your personal needs, objectives and financial circumstances. You should consider whether it is appropriate for your situation. Please read the applicable Disclosure Documents before acquiring any product described on this website. Please also review our Financial Services Guide (FSG) before accessing information on this website. Information on this page can change without notice to you.

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