Compound Interest

What is compound interest?

Compound interest refers to a method of calculating the cost of borrowing or the earnings on an investment where the amount grows based on both the initial principal and the accumulated amount over time. This means that if you borrow money, you pay interest on the total amount owed, including any previous interest added. Conversely, if you invest, your total amount grows faster because you earn on both your original investment and the additional amounts over time.

What is an example of compound interest? 

Loan example (interest owed) 

Suppose you take out a loan of $1,000 with an annual interest rate of 5%. After the first year, you owe $1,050. 

In the second year, the interest is calculated not just on the original $1,000 but on the new total of $1,050. 

So, you'd owe $1,102.50 after the second year, and the interest keeps compounding. 

Savings example (interest earned) 

If you deposit $1,000 in a savings account with an annual interest rate of 3%, after the first year, you'd have $1,030. 

In the second year, the interest is calculated not just on the initial $1,000 but on the new total of $1,030. 

So, you'd have more than $1,060 after the second year, and your savings keep growing. 

How frequently is interest compounded? 

Interest can be compounded at different intervals, such as annually, quarterly or monthly. When compounding occurs more frequently than once a year, it influences calculations for both future and present values.