What Is Compound Interest?

Compound interest is one of those words that is bandied about when discussing bank accounts and investments. Compounding interest is really a very simple concept once you get your head around it.

 How this type of interest works (This example is with savings):

Attached to your account is an agreement with the bank, this will state an interest rate, and the interest payment interval. However unlike simple interest where the interest accrued is paid out at the end of each month/year, compound interest is cumulative. This means that every time interest is due to be paid, the amount of interest is recalculated (based on the current balance). Interest paid into the account earlier has been added to the balance. Therefore your interest also earns interest!

If you do not need access to the interest it is a good way of growing your investments and making the most of your money. Your investments will grow at a much more rapid rate.

So is compound interest always a good thing?

Compound interest can be both a help and a hindrance when it comes to reaching your financial goals. This means you are essentially earning money for nothing! This means that if you are not making large repayments, the debt on your loan will increase - before you know it a $1000 debt will not be getting paid off at all, interest will be compounding on the balance and the debt will be much higher!

For this reason be wary when entering into debt with compound interest and short term periods- often the less reputable firms use this as a way of increasing your debt!

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