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Simple English definitions for legal terms
compound interest
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A quick definition of compound interest:
Compound interest is when you earn interest on the money you already earned from an investment. This means that your investment grows faster over time. It's different from simple interest, where you earn the same amount of interest every time. Compound interest is important in finance and trading. You can calculate the total cost of a loan with compound interest using a formula. For example, if you lend someone $1,000 with a monthly interest rate of 10%, they would owe you $2,593.74 after ten months with compound interest.
A more thorough explanation:
Compound interest is a type of interest that is earned on both the initial investment and any interest that has been accumulated over time. This means that the interest earned on an investment is added to the principal amount, and the new total amount earns interest again. This cycle continues, resulting in a larger return on investment over time.
For example, if you invest $1,000 in a savings account with a 5% annual interest rate, after one year, you will have earned $50 in interest. However, if you leave that interest in the account and continue to earn interest on the new total of $1,050, you will earn even more interest the following year. This compounding effect can result in significant returns over time.
Another example is a loan with compound interest. If you borrow $10,000 with a 10% annual interest rate and a term of 5 years, you will owe $16,386 at the end of the term. This is because the interest is added to the principal amount each year, resulting in a larger amount owed.
Compound interest is an important concept in finance and investing, as it allows for exponential growth over time. It is important to understand the effects of compound interest when making investment or borrowing decisions.