Compound Interest Explained

By Author: Bonny Kominek
Total Articles: 32
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Interest that accumulates upon interest is known as compound interest. The compounding rate is the frequency at which interest is added to the balance, and this can have a large bearing on how much interest will accumulate on a balance over a period of time.

If you were to put a hundred pounds into a savings account with a monthly interest rate of one percent, you would have a hundred and one pounds the next month. One percent of a hundred and one is 1.01, so after two months you would have 102 pounds and one pence.

If you want to get a clear idea of how much interest will accumulate over the course of a year, you have to know both the interest percentage and the rate at which it is added. It is usually easier to think of interest rates as an annual percentage rather than as a monthly rate.

Over the course of a year, a bank account with a one percent monthly interest rate would provide an annual interest rate of about 12.68 percent. This aggregate annual percentage is usually called the APS (Annual Percentage Rate) or the AER (Annual Equivalent Rate).

Usually the APR or AER of a financial product ...
... is inclusive of any bonuses or charges that might be applied over the course of the year. For example, if you received a one percent bonus for keeping up the payments to a regular savings account, this would be added to the advertised annual rate.

The effects of compound interest are magnified when considered over longer time periods. For instance, an investment of a thousand pounds in a savings account with an AER of four percent would increase in value to 2191.10GBP over the course of twenty years. If the interest rate were not compounded, the balance would only grow to 1800GBP in the same period.

The easiest way to work out how much a particular mortgage is likely to cost you is to use a mortgage calculator, such as the one found on the Alliance and Leicester website. These enable you to type in all the details of a mortgage deal, and find out quickly how much your monthly repayments are likely to cost.

Mortgage calculations are quite complex, but mortgage calculators can make them a lot easier. All you have to do is enter the size and length of the mortgage, the size of the deposit, and the interest rate, and it will let you know how much that mortgage is likely to cost every month. Bonny Kominek is the author of this article. Alliance