Compound interest

Compound interest is interest that is calculated based on both the outstanding principal and any interest that accumulated in prior periods. It may be calculated several times a year, such as on a monthly or quarterly basis. A greater degree of calculation frequency equates to a more rapid rate of growth in the amount of interest.

When compounding is used, the amount of interest calculated greatly exceeds the amount derived under a simple interest calculation (where interest is derived only from the amount of principal). This can be a major concern when compounding is introduced into the calculation of a consumer loan, since the consumer will end up paying far more interest than would have been the case if a simple interest calculation had been used instead.

In the Excel electronic spreadsheet, the calculation for compound interest is:

Principal x ((Annual interest rate ÷ 100) + 1)^number of years

Similar Terms

Compound interest is also known as compounding.