When a bank gives you money, it’s called a loan. The bank expects you to pay it back with a little extra called interest. Think of it like borrowing a book from a friend: you promise to return it, and maybe give a bookmark as a thank‑you.
An overdraft lets you spend more than you have in your account, up to a set limit. It’s like a safety net.
Limit: The maximum amount you can overdraw.
Interest: Charged only on the amount overdrawn.
Example: If your account balance is £50 and you spend £70, you’ve overdrawn £20. If the overdraft rate is 5% per annum, the annual interest on £20 is \$I = P \cdot r = 20 \times 0.05 = £1\$ (simplified for illustration).
Tip: Always check if your bank offers a “free” overdraft or a “paid” overdraft with a lower rate.
Loans are used for larger purchases like a car or a house. They come in different types:
Interest can be simple or compound:
Simple: \$I = P \cdot r \cdot t\$
Compound: \$A = P(1 + r)^t\$
Where:
Example: Borrow £10,000 at 4% per annum for 5 years, simple interest:
\$I = 10{,}000 \times 0.04 \times 5 = £2{,}000\$
Total repayment: £12,000.
| Year | Principal (£) | Interest (£) | Total Payment (£) |
|---|---|---|---|
| 1 | 2,000 | 400 | 2,400 |
| 2 | 2,000 | 400 | 2,400 |
| 3 | 2,000 | 400 | 2,400 |
| 4 | 2,000 | 400 | 2,400 |
| 5 | 2,000 | 400 | 2,400 |
Before lending, banks check:
Higher credit scores and stable income usually mean lower interest rates.
1️⃣ Understand the difference between overdrafts and loans. Use the analogy of a safety net vs a big purchase.
2️⃣ Memorise key formulas: \$I = P \cdot r \cdot t\$ and \$A = P(1 + r)^t\$.
3️⃣ Practice interpreting amortisation tables. Know how to read each column.
4️⃣ Highlight creditworthiness factors. Be ready to explain why banks charge higher rates to riskier borrowers.
Good luck! 🚀