Making interest rates easy to understand for your child
Quick insights
- As you teach your kid about interest, you may want to start with real-life examples to help them understand. You can use allowance, chore money or toy purchases to explain how interest works when borrowing or saving.
- Keep it simple by using stories, charts or playing pretend bank to show how interest grows money (or costs money).
- You can point out interest in action—on bank statements, savings apps or even credit card bills—to show how it plays a role in real life.
Helping your child understand money is a valuable lesson you can give them—and interest rates are a key part of that. Whether they’re saving for a toy or one day applying for a credit card, understanding how interest works can empower kids to make smarter financial decisions throughout their lives. This is how compound interest helps your money grow faster—because the interest you earn also starts earning interest.
Start with the basics: What is interest?
Before diving into calculations or credit cards, start by explaining what interest is. Use relatable, everyday examples.
Try this simple definition:
“Interest is money earned or paid for saving or borrowing money.”
Use kid-friendly examples:
- Borrowing example: “If you borrow $10 from me and I say you need to give me $11 back next week, that extra $1 is interest you are paying to borrow money from me.”
- Saving example: “If you save $10 in a bank account and it earns $1 after a while, that’s interest you earned for keeping your money with them.”
Types of interest: simple vs. compound
Once your child gets the basic concept, you can introduce the two main types of interest: simple and compound. Use visuals, charts or short stories if it helps make the explanation more concrete.
Simple interest
Kid-friendly definition: “Simple interest is the interest or amount you earn (or owe) that is based on the starting amount.”
Example: “If you put $100 in a savings account that earns simple interest of 2%, you would earn $2 every year.”
Compound interest
Kid-friendly definition: “Compound interest is when you earn (or owe) money not just on the original amount, but also on the interest that’s already been added.”
Example: “Let say you put $100 into a savings account that earns 5% interest each year. After one year, you earn $5 in interest, bringing your total to $105. In the second year, you earn interest on the full $105, not just the original $100. That means you’d earn about $5.25 in interest. Now your total savings is $110.25. This is how compound interest helps your money grow faster—because the interest you earn also starts earning interest.
Show them how interest is calculated
Introduce simple interest first, since it’s easier to understand. Use this formula:
Simple interest formula:
Interest = Principal x Rate x Time
The principal is the starting amount. In this case, the $100 you initially deposit.
Walk them through an example:
- Principal (starting amount) = $100
- Rate = 5% (or 0.05)
- Time (in years) = 2
- Interest = $100 x 0.05 x 2 = $10
If you save $100 at a 5% simple interest rate for two years, you’ll earn $10 in interest, making your total savings $110.
For compound interest, you can introduce this formula once they understand the basics:
Compound interest formula:
Compound interest = Principal x (1 + Rate) ^ Time
- A = P x (1 + r) ^ t
- A = compound interest
- P = principal (starting amount)
- R = interest rate per period
- T = number of periods
Example: $100 x (1 + 0.05) ^2 = $110.25
This means after two years, you’d have $110.25. That includes your original $100 plus $10.25 in interest, which is slightly more than simple interest because you earned interest on your interest in the second year.
Teaching kids about credit card interest
Credit card interest can be an important lesson, especially as your child gets older and starts thinking about accounts or college spending. Here's how to explain it clearly.
What to tell them:
- Credit cards are like borrowing money that you promise to pay back.
- If you don’t pay the full amount by the due date, you will be charged interest on what’s left.
- Interest rates on credit cards are usually much higher than savings rate, so it can be easy to end up paying more than you originally spent.
Use a scenario: “Let’s say you put $100 toward a car repair on your credit card, but only pay back $50 by the due date. If your credit card has a 20% annual interest rate, interest is charged on the remaining $50. Here's how it breaks down:
- Monthly interest rate = 20% / 12 = 1.67%
- Interest added = $50 x 0.0167 = $0.84
Next month, you’ll owe $50.84, not just $50. If you keep carrying a balance, the interest keeps building, meaning your repair could end up costing more than you expected.
When do you pay interest?
Parents can help their kids understand what happens when people borrow money.
Kid-friendly explanation: “When you borrow money, like with a loan or credit card, you usually have to pay extra money back on top of what you borrowed. That extra part is called interest.”
Ways to explain it:
- Use a pretend loan at home: “If I lend you $20 to buy a toy, and I say you have to give me $22 back next week, that extra $2 is interest. It's the cost of borrowing.”
- Relate to real life: “When people use a credit card or take out a loan to buy a car or go to college, they often pay interest.”
- Make it stick with a simple rule: “You pay interest when you borrow money. The longer you take to pay it back, the more interest you usually owe.”
When do you earn interest?
Now flip the coin and talk about how interest can actually work for them when they save money.
Kid-friendly explanation: “When you save money in a bank or a savings account, you will earn a little extra money over time. That's interest that you're earning for keeping your money at the bank.”
Ways to help kids connect the dots:
- Make it a game: Let your child play ”banker” and pretend to give you interest when you “deposit” money into their toy bank. Switch roles so they can see both sides of saving and borrowing.
- Look at a bank statement together: If your child has a savings account, show them where interest appears—even if it’s just a few cents. Point out that it’s money they didn’t have to earn with chores or allowance.
- Talk about time: Remind them that interest takes time to grow. “The longer your money stays saved, the more it can earn. With patience, you can watch your money grow over time.”
Simple rule for kids to remember: “You earn interest when you let your money sit in a savings account. Over time, your money grows all by itself—even while you’re sleeping.”
Tips for helping kids manage interest wisely
Here are some hands-on ways parents can help children grasp the power of interest and how to use it wisely:
- Open a kids’ saving account with interest and check it monthly together to see how it grows.
- Play “bank” at home: Have your child deposit money with you and earn simple interest over time.
- Use educational apps or games that simulate earning or paying interest.
- Teach them to pay off credit card balances in full when they’re older—emphasize how this helps avoids interest charges.
- Compare interest rates together when shopping or researching banks; turn it into a real-world math lesson.
In summary
Teaching your child about interest doesn’t have to be complicated. With real-world examples, simple math and interactive lessons, you can lay the groundwork for a lifetime of smart financial decisions. The earlier your kid understands interest, the more prepared they’ll be to save, borrow and spend responsibly as they grow.
