Compound interest is the interest collected on the principal amount of the deposit amount, as well as the interest already added onto the principal during past payments. In other words, every time that interest is added, or compounded, onto the principal amount, it creates a new amount that will be further compounded next time a collection dates arrives. Simply put, compound interest applies to the entire amount, not just the principal. Because of this, over time, money slowly accumulates and the total amount of the account increases.
Consequently, the amount due on the payment date increases as well. Compound interest is most commonly found in savings and checking accounts, along with interest due on home loans.
How Compund Interest Is Arrived At
There is a simple mathematical formula used for calculating compound interest, which is:
A = P(1 + r)n
-A = amount accumulated after interest in compounded
-P = principal
-r = annual interest rate
-n = number of years interest is collected
It is important to note that if the interest is being compounded more often than once per year, the value for “r” is divided by the number of times interest is being compounded (i.e. if monthly, with an interest rate of 5%, it would be 5/12).
As previously mentioned, compound interest adds additional interest money to the interest that was already paid. Therefore, with time, you will be collecting money simply by having your money deposited in an account.
Compound interest often works the same with loans, which means that the longer it takes you to repay the loan, the more you end up paying. This usually works as a major incentive for borrowers to repay their debts as quickly as possible to save money.
As is the case with most financial situations, it is important to take your time. Shop around and explore your loan options to find the best compound interest rates. This applies to both accounts and loans. Remember to request quotes from multiple sources, so that you can effectively compare the rates offered and choose the best one according to your situation