In a world full of finances, any person can benefit from learning what interest is, how it applies in certain backgrounds, and how to calculate it. For example, taking out a loan to cover expenses could produce a lot or a little interest depending on the interest rate and how the person calculates the amount. Understanding simple interest vs. compound interest could save you money or earn you more money.
Compound Interest is the total amount of interest and principal amount reinvested over multiple time periods.
In other words, at the end of a time period your interest is added to your principal amount and then that amount becomes reinvested over and over again based on the time period in years.
The chart below shows how much more money is created when using compounded interest compared to simple interest.
Here are two scenarios that can apply to compounded interest.
1. Borrow/Get a Loan
Borrowing money with a compounded interest rate is bad! Very Bad! Over time, you must pay a lot more back to the bank since the amount exponentially increases.
Investing money with a compound interest rate is amazing! Very Amazing! Take the opposite of what was said above. Your money will exponentially grow and you will be rewarded with more money than a simple interest rate.
Remember: The compound interest formula does not yield interest because it is the principal amount AND the interest.
Here’s a quick example without any context: