There are two conditions of interest. One is when people pay interest while repaying debts, and the other is what people get from their savings in the bank. When one must pay interest, it is the worst possible thing. But when people are paid interest on their savings by doing absolutely nothing, it is the best thing.
This article covers the type of interest that can be incredibly beneficial for people!
Types of interests
There are two basic types of interests: compound and straightforward part. Many people clearly understand what simple interest is. The interest type used in mortgage, automobile, and other short-term loans is applied to the principal amount borrowed.
A “borrower” enjoys the advantages of simple interest. The payment and the interest paid are deducted from the principal amount, reducing the amount payable when an individual is regular with payments.
The second type of interest and the focus of this article is compound interest. Compound interest boasts excellent benefits to investors and those who have savings. Unlike the simple part, compound interest applies to the principal amount plus the interest already paid or earned. It is a more complex type of interest and is not as easy to calculate as simple interest.
Understanding compound interest
The use of compound interest dates back to the 17th century and is known to have originated from Italy. It is an interest calculating method that makes an amount grow at a faster pace as compared to the simple interest.
Here is an example to help people understand what compound interest is!
For instance, a person borrows $2,000 for three years at an interest rate of 10% with a fixed payment of $500 per annum. The total amount payable will be $1,507.
In the first year, 10% interest will apply to the principal amount, which will make the amount reach $2,200. For the second year, the person will pay $500. The principal amount then reduces to $1700, and the interest amount you will have on the reduced amount. At the end of the second year, the amount payable will reduce to $1,870. Similarly, at the end of the third year, the expected amount will be $1,507. The total interest paid by the end of the three years will be $507.
Benefits of compound interest
It can work wonders for people saving for their retirement or who have kept the amount to earn profits.
Simple interest is not very beneficial for people putting away their money for retirement. But compound interest can help them reach their savings goal quicker. How? The interest rate will apply to not just the principal amount but to the sum of the principal amount and the total amount of interest received. Therefore, a person will not need to juggle the finances. Instead, they will be able to increase their savings just by keeping them in one place. It is one of the ideal ways to invest and enhance protection. The longer people keep their money in the bank, the higher the interest accrued, which looks like a perfect situation.
Get benefit from your compound interest’s knowledge!
You can use all strategies and financial ideas to have enough knowledge about using compound interest. Find the best savings account that provides you daily compound interest rather than in a month or year. In this way, you can transfer your saved money into your savings account as fast as possible.
Pay all your credit card amount within a month to reduce the interest accumulation and compound. Also, pay off all your balance within a month whenever it seems possible for you.
The drawback of compound interest
Compound interest proves to be exceptionally beneficial for investors and savers. But in the case of repayment of loans and debts, it can be very damaging. The major drawback of this type of interest comes with an error in estimation. If an estimation error occurs in the first year, it will be carried forward to the remaining years of repayment. For example, if an individual wrongly estimates in the second year of the ten-year repayment period, the error will propagate through the next eight years. By working out the forecast smartly, people can overcome the problem of estimation errors!
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