What is Compound Interest?

Compound interest is a type of interest that is applied to the initial principle of a deposit or loan and to each subsequent accumulation of interest going forward. Commonly described as interest on interest, compounding interest increases at the rate of a predetermined frequency of compounding. With each period, interest is applied on top of the initial principle plus the interest accrued thus far on the initial principle.

Calculate compound interest with this formula:

Compound Interest = Principle x [1 + (Interest Rate/Compounding Frequency)] (Compounding Frequency x Number of Periods)

What does compound interest mean for your investment or loan? The party collecting the interest benefits more from applying compound interest. Collecting on a compound interest deposit will yield increasingly more interest with each period. When paying a loan with compound interest, the level of debt increases exponentially with each compounding period.

The compound interest definition contrasts with that of simple interest, in that simple interest is applied solely to the initial principle over each period.

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