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Compound interest: What it is and how to calculate compound interest

Compound interest is one of those terms that few understand very well, and that in the long run can significantly affect payments related to a personal loan.

Knowing in depth all the details inherent in the hiring of a loan can guarantee you a more positive experience in the market of financial products. For this reason we have prepared this article to explain everything about compound interests.

If you do not want to deal with interest composed of a credit, or any other type of interest, keep in mind that you can apply for interest-free loans in some circumstances.

What is the composed interest?

Compound interest in monetary assets is the interest that is added to the initial capital and over which new interest is generated.

The relationship that the compound interest has with the loans lies in its ability to add the interest generated in each period of time to the initial amount you requested.

That means that interest is accumulated to increase the amount, and therefore new interest is generated for the next term and so on until the debt is finished paying.

How to calculate compound interest?

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In the event that you apply for a loan with this interest rate, it will be very useful to know how to calculate it. Here we show you how to do it through a formula, and some real examples.

Compound Interest Formula

To calculate the compound interest rate you should know that the final capital to be repaid (Cn) at the end of the loan is equal to the initial capital requested (Co) multiplied by 1 plus the interest rate (i), raised to the power of the period of time considered (n); that is to say:

Cn = C0 (1 + i) ⁿ

Be careful to include the interest rate in the correct format, as it is a percentage (you must divide by 100). That is, if the rate is 5% you must place 0.05 in the formula.

If you are using an annual interest rate, “n” in the formula will be the number of years of the loan; If it is monthly interest, “n” will be the number of months.

Example of compound interest

If you apply for a loan of $ 10,000 with compound interest at an annual interest rate of 5% to be repaid within a period of 5 years, you will end up paying $ 2,762.8 of interest as explained in the following example year by year:

That is, you will return $ 12,762.8 after the $ 10,000 that they had initially lent you.

The example table shows how compound interest increases the initial amount requested, which means that the more time passes, the percentage to be paid is higher. To compare, in the case of a simple interest, each year you would have paid only $ 500 of interest.

Compound Interest Calculator

A compound interest calculator is a perfect ally to find the specific result to pay on loans with this interest rate. Simplify the process, grant fast and transparent results, and prevent you from complicating yourself.

Differences between simple and compound interest

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The main difference between simple interest and compound interest is that the former does not capitalize again on the interest or benefits generated by the amount initially requested.

For its part, compound interest does capitalize on that percentage of profit or interest and adds it to the amount borrowed in order to add higher interest in the following term.

Another notable difference is that the percentage to be paid on simple interest loans is maintained for all payment terms until the end.

Learn more about calculating interest and loan installments in Good Finance.

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