In finance management, compound interest plays an integral role. Among the two important interest rates, the compound is the most desirable one because it helps to earn a high return on investment. However, while it feels great during earning money, on the contrary, it feels excessively disgusting while repaying a huge amount.
Unlike, simple interest this compound rate too is offered by banks and other financial institutions. An investor can earn a good amount of return only after investing money ata compound rate. On the other hand, when a person borrows money at a high rate of interest then it means the lender applies a compound rate.
For this reason, before borrowing money from a money lender you need to be sure about the interest rate and type of interest. If you are looking for bad credit loans with guaranteed approval and no guarantor then always select a direct lender. None but only direct lenders offer a comparatively low rate of interest even if it is a bad credit loan.
So, let us know more about compound rates so that you can choose lenders as well as an investment plan.
What is the compound rate of interest?
The continuous accumulation of interest on its principal is known as a compound interest rate. Generally, it is an accrued interest on simple interest. When interest over interest takes place then compound interest reflects into the account. Good-performing funds offer such a huge amount of interest to their investors.
On the other hand, when a lender lends money at a high rate of interest or applies a hidden interest rate on the borrowed amount then a compound rate can take place. Short-term loans come with such a rate of interest. Many finance companies whose main focus is to lending money, usually, those money lenders impose a high rate of interest.
The formula of calculating compound rate of interest is,
A = P (1+[r / n] ^ nt)
This formula is used to count the amount earned out of the compound rate. Here A denotes amount of money, P denotes the principal amount, r denotes the rate of interest, n denotes time or number of compounding rate in an entire year i.e. half-yearly or annually and t denotes the total time of the period up to which compound interest rate will be paid.
How to calculate compound interest?
Before we discuss calculation let us know first the basic concept of compound interest. To understand how it works you need to know first simple interest. This is something that almostevery financial institution offers to people in exchange for investment. There is no doubt that simple interest comes with a low rate of interest.
When a person deposits money in his savings bank account then he earns some extra amount in the form of simple interest. Besides, the frequency level of interest credit is also lower than the compound rate. Only once in a year, simple interest is credited.
On the contrary, compound rate offers a high return on savings. There are many high-interest paying savings accounts, where account holders can earn a good amount of interest. To calculate the total amount earned out of compound rate one may use the above-mentioned formula. However, apart from following the formula one may choose the rule of 72.
- Rule of 72
When people visit a financial advisor for managing finance and increase economic stability then most of the advisors used to apply this rule. It helps one to understand how much he will earn after investing money for a particular period. Besides, after applying this rule of 72, one can easily get an estimate for how much time one needs to keep the money invested.
After multiplying the time with a specific rate of interest offered by a particular investment fund, if the result is 72 then you can be sure about a high return.
However, some investment banks offer an only a compound rate of interest to attract more consumers. Whereas normal banks and financial intermediaries offer compound rates quarterly or half-yearly, such investment banks and some online banks offer more than that. Especially, online banks offer compound interest even daily which is credited to the account monthly.
On the other hand, for borrowers, compound interest behaves completely reverse and a borrower needs to pay a huge amount of money at the form of repayment. When a lender lends money at a compound interest rate then a borrower should pay more than what he borrowed. However, sometimes lenders used to ease the borrowers by offering the option of repayment in two parts. According to them, they can pay the principal amount through monthly installments, and once it completes starting paying the interest only.
Reasons for the popularity of compound interest
There is no doubt that apart from any other rate of interest compound interest has earned huge popularity among investors. According to finance experts, interest over interest is the main reason for its popularity. Investors and financial planners find those shares and funds more profitable which offers compound interest.
- Frequent interest credit
As mentioned, the presence of a compound rate is more frequent than simple interest. While one account holder can get a good amount of rate of interest thrice in a year, simple interest only credits once in a year. So, there is no doubt that frequent interest credit can offer a very good amount of return on investment.
- A Longer period of investment offers a huge return
It is quite common in a compound rate that the longer one keeps the money within the account, the scope of lump sum takes place. Therefore, if you want to enjoy a high value of return then make sure you have invested money in acompound rate of interest. Usually, when an investor invests money in shares then the financial advisor advises for a long lock-in period. The reason behind such alonger investment period is getting a high return.
- Benefitted lenders
While lending is a business, if the lender (businessman) lends money at a high rate of interest (i.e. compound rate) then he can earn a huge amount of return. Although it benefitted lenders but created an extra burden to borrowers. If the borrower agrees to pay as per compound rate then he needs to repay a huge amount of money.
On the other hand, instead of borrowing from those money lenders if a person borrows 24 7 loans from direct lenders then he can minimize the requirement of extra payment easily. So, before borrowing money a borrower must make sure that he is not borrowing from the compound rate of interest lenders.
The compound rate of interest benefitted lenders and investors. On the contrary, it does not benefit the borrowers. Such a high rate of interest helps to double the savings amount.