Difference Between Simple and Compound Interest

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“Simple interest” and “compound interest” are two terms that are commonly associated with loans and debts. However, how well do you understand these terms? Let’s discuss these terms and help you gain a better understanding of them

Simple Interest

Simple interest is an interest rate based on a percentage of the principal amount. It is computed by multiplying the principal amount by the annual interest rate and the number of months or years for which money is borrowed. For instance, if you borrow $2,000 with a simple interest rate of 6% for 5 years, then you would pay $600. Simple interest is common on traditional loans and mortgages.

Compound Interest

Compound or compounding interest is a loan interest based on the initial principal and the accrued interest from the previous months. In other words, it is interest on an interest that is compounded at any given time interval. The most common example is credit card debt. Credit card debt interest generally compounds daily. For instance, if you have a $10,000 balance on your credit card with a daily interest of 0.040%. You’d owe the bank $10,004 on the first day, $10,008 on the second, $10,012 on the third, and so on

Simple Interest vs Compound Interest

From a borrower’s perspective, simple interest is preferable because it is easier to pay and doesn’t cause a lot of burden to those who are in debt. Meanwhile, compound interest can add up quickly and put a lot of burden on your finances if not paid on time.

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