Compound Interest Explained

Compound Interest impacts your finances so it’s important to be clear about what it is, how to deal with it and the ways it can benefit you right?

By definition, compound interest is interest calculated on both the principle amount of a financial note and any accumulated interest from previous periods.

Compound Interest is arguably the most powerful force in finance. Its capacity to grow over time can make investors quite wealthy.

Albert Einstein said, “Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it.”

So what does it look like?

If you have $1,000 in an account with an ANNUAL interest rate of 10% you will have $1,100 at the end of the year. The next year, the interest is based on the new amount of $1,100 which will now grow to $1,210. Your money will continue to build on itself and after 10 years the original $1000 will have grown to $2,592.

In this instance, compounding interest is working FOR you.

Now, let’s look at when it’s working AGAINST you.

Many credit cards have higher interest rates and accrues DAILY meaning your debt is growing at a much faster rate. This is why it’s a good idea to avoid carrying a balance if possible. If your payment covers the interest accrued, the interest will not build on itself.

Generally, federal student loans and mortgages don’t have compounding interest However, if your monthly payment doesn't cover the monthly interest, then your overall loan balance may grow. This is called negative amortization.

When unpaid interest is added to your principal (original balance), then the interest rate may apply to that larger balance...in other words, the interest compounds.

When you're applying for any type of loan, especially a large one, make sure you understand how interest accumulates and when it compounds (if at all).

Schedule a time that works best for you so we can go over exactly how compound interest is for or against you.