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
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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. ”
