PSHE KS3 / KS4: Interest - How does compound interest work?

Steph McGovern brings you up to speed on interest and how it's calculated.

When you borrow money from a bank or building society, they charge interest; money you pay back on top of what you borrowed. What it costs depends on the interest rate and how long you take to pay what you owe.

And if you save money with a bank or building society? They pay you interest on top of your savings.

So, whether you're borrowing or saving, it pays to know about interest.

Teacher notes

Choose from a selection of activities to help students learn more about borrowing, saving and interest.

Before watching

Questions to get the class thinking and talking...

  • What is interest?
  • When do you earn interest?
  • When do you pay interest?
  • What should you consider before saving or borrowing money?

Establish 'interest' is a charge made to borrow money or a payment you get when you save money.

Using the film

You may wish to play the film twice: once straight through and once with pauses, to take students' comments and questions.

When Steph discusses compound interest, you could pause at each step of the calculation. Ask students to take notes.

After watching

  • Role-play - Students could take turns playing Steph McGovern (or her secret twin Stefan) and guide the class through the calculation of compound interest for a different APR from that used in the film. Encourage their classmates to ask Steph or Stefan questions about the steps in the calculation.

Ask, 'So what's the difference between simple interest and compound interest?' Establish that with compound interest, you pay 'interest on the interest that has built up since you started borrowing', or you get paid 'interest on the interest that has built up since you started saving'.

Activity ideas

  • Compound challenge - Give students 5 minutes to learn by heart Steph McGovern's explanation of compound interest. They'll find the wording in the video transcript (from 'And that's down to something called compound interest,' to 'But it's difficult to calculate, isn't it?').

Hide the video transcript and challenge individual students to repeat Steph's script from memory. Their classmates can prompt them if they get stuck.

Make this challenge trickier by requiring each student to perform a task while reciting: hopping on one foot, balancing an object, bouncing a ball or keeping a balloon in the air.

This fun activity helps students rehearse the main lesson information.

  • Glossaries - Students could compile glossaries of financial terms used in the film clip, along with their own definitions. This encourages them to clarify their understanding of key vocabulary. Terms might include: 'interest', 'compound interest', 'interest rate', 'loan' and 'APR (Annual Percentage Rate)'.

  • Rate tables - Ask the students, individually or in pairs, to draw up a table showing the compound interest you would pay if your borrowed £1,000 at 12% over 5 years. You could give the class this outline table...

YEARAMOUNTAPRINTERESTTOTAL
Y1£1,00012%
Y2
Y3
Y4
Y5

Students could go on to calculate the simple interest generated on £1,000 at 12% over 5 years. Ask, 'What's the difference between the two kinds of interest?'

  • Bar charts - Students could draw bar charts to illustrate their rate tables. They could represent each year of borrowing as a pair of columns. The first column could show the simple interest generated and the second record the compound interest.

Graphing clearly illustrates the cumulative impact of compound interest on the borrower.

  • Shopping around - Whether you're a borrower or a saver, it pays to shop around and compare the offers banks and building societies make. Not all bank accounts pay interest and not all savings accounts offer compound interest.

Students could work in groups to check an online price comparison website. Can they find the best deal for someone who has £500 to save and the best deal for someone who needs to borrow £500?

  • Borrowing plan - Ask, 'Before you borrow money, you should make a plan for how you'll pay it back. What would this plan look like?' The students might suggest listing their income and outgoings, to see what they can afford.

Supported learning and SEN

Students could (with any necessary support) use an online interest rate calculator to explore the interest gained on savings at different APRs.

Closing the lesson

Students could share their recommendations from the shopping around task. The class could take a vote on the best deal for a saver and for a borrower.

Draw the students' attention to the 'small print', the terms and conditions of the offers they recommended. Sometimes, hidden penalties in these agreements make them less attractive.

If you're saving or borrowing, you need to check the 'small print' when looking for a deal.

Follow-up task

Ask the students to pick up a leaflet about a savings account from their local bank or building society. They should carefully scan the 'small print', underlining or highlighting any penalties that might make this account less attractive.

Curriculum notes

This short film meets and extends curriculum requirements for financial literacy at:

  • Key Stage 3 and Key Stage 4 in England (Citizenship and Personal, Social, Health and Economic Education)
  • Wales (Mathematical Development and Personal and Social Education)
  • Northern Ireland (Mathematics and Numeracy and Learning For Life and Work)
  • Third and Fourth Level and the Senior Phase in Scotland (Mathematics and Numeracy, Social Studies and Learning, Life and Work).

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