Compound Interest

The addition of interest to the principal sum of a loan or deposit.

Compound interest is sometimes referred to as compounding interest or ‘interest on interest’. It differs from simple interest – which is calculated only on the principal amount – in that it is calculated on both the initial principal and the accumulated interest of previous periods of a deposit or loan.

How fast does compound interest accrue?

While compound interest will certainly cause a sum to grow at a faster rate than simple interest, the exact rate at which it accrues depends on the frequency of compounding. Higher numbers of compounding periods equate to greater compound interest.

Practical Application Example

“ Let’s assume that you are borrowing £3,000 over a three-year period, while paying 10% annual interest on the debt and not making regular repayments. After one year, your compound interest would be £3,000 x 10% = £300. This means that at the end of year two, your compound interest would be £3,300 x 10% = £330, and the calculation for year three would be £3,630 x 10% = £363. This equates to a potential repayment figure after three years of £3,993, with the £993 interest being the sum of each year’s interest. ”