Introduction to compound interest
- Compound interest (or compounding interest) is known as the interest on a loan or deposit calculated based on the initial principal as well as the accumulated interest from previous periods.
- Believed to have originated in 17th-century Italy, compound interest can be thought of as "interest on interest". It will cause a sum to grow at a quicker rate than simple interest, which is calculated only based on the principal amount.
- The speed at which compound interest accrues is based on compounding frequency, such that the greater the number of the compounding periods, the higher the compound interest.
Understanding Compound Interest
Compound interest is used when interest gets added to the principal amount invested, and then the interest rate applies to the new principal. It's essential interest, which over time results in exponential growth. Compounding can work to your advantage when your savings and investments grow over time—or against if you're paying off debt.
Formula For Compound Interest
The formula for compound interest is
A = P(1+r/n)nt
P is the principal or also the starting amount r is the annual interest rate, which is usually written as a decimal n is the number of times the interest compounds every year t is the total time or total number of years A is the total amount you will end up with at the end of the timeframe
You can make use of one of the many online calculators to calculate how much interest will accrue and how compounding can affect your savings or debt. However, the formula can contribute insight into how compounding works.
Whether you're saving up or borrowing money, you may already know the amount you'll begin with (P) and the timeframe (t). As a result, there are 2 variables to contemplate as you compare your options—the interest rate (r) and the compounding frequency (n).
Simple Interest Vs Compound Interest
Interest is known as the cost of borrowing money, where the borrower has to pay a fee to the lender for the loan. The interest expressed as a percentage can be either simple or compounded—simple interest depends on the principal amount of a loan or deposit. In opposition, compound interest depends on the principal amount and the interest that accumulates on it in each period. Simple interest is calculated based on the principal amount of a loan or deposit, so it is simpler to determine than compound interest.
