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There are two types of interests, i.e. simple interest and compound interest. While the simple interest is paid only on the principal amount, under the compound interest, the interest paid in the previous month is added to the principal amount to give you a new balance in your account. The interest for the following month is payable on this new balance. Below is all the information about compound interest.

Whether you put any money away in a bank or borrow money from a financial institution, an interest is applicable. With savings you earn interest and with borrowings, you are liable to pay interest.

Whether it is saving or borrowing, you can also expect one of the two types of interests – simple interest or compound interest. With simple interest, you pay the interest only on the principal amount. However, with compound interest, the interest that you pay in the previous month is added to the principal amount to give you a new balance in your account. The interest for the following month is payable on this new balance.

In simpler terms, compound interest means that you get ‘interest on interest’.

Compound interest is extremely beneficial when you are looking at a savings account. It is a great way to earn more with your savings. Unlike simple interest, which only takes into account the initial deposit, compound interest gives you the advantage of a new account balance each month with added interest. This amount may not seem very high initially. However, with long-term deposits, you can earn quite well on your savings with compound interest.

The flip side of compound interest lies in making any repayments. Now, with any loan such as a Home Loan, Car Loan, or Personal Loan, the repayment is broken down into monthly installments. So, you won’t really have to worry about compound interest. However, when it comes to Credit Cards, compound interest can get you in trouble. If you only pay off the minimum amount on the balance due, you will be charged a compound interest on the remaining amount. This can make the repayment amount extremely high within a short period of time.

The basic difference between simple interest and compound interest lies in the amount that the interest is charged on. To help you understand better, here is a detailed difference between simple interest and compound interest:

Simple Interest	Compound Interest
This interest is only levied on the principal amount or the loan amount.	The interest is levied on the loan amount as well as the interest that is added to it each month.
This is a small percentage of the principal amount as agreed between the lender and the borrower.	This is a percentage of the principal amount along with the simple interest that is earned upon the principal amount as agreed upon by the lender and borrower.
Wealth and repayment amount in case of loans increase steadily.	Whether it is savings or the repayment on your loan, the growth of the amount is faster because of compounding.
The returns with simple interest are lower.	You get higher returns with compound interest.
The principal amount does not change.	Interest is added to the principal, making it increase accordingly.
Simple interest is very easy to calculate as the formula is straightforward.	This is harder to calculate because of the compounding on the principal amount.

You have the advantage of several online EMI calculators to help you calculate compound interest on savings and borrowings. However, it is important for you to know how this value is determined to manage your wealth better.

Now, compound interest may be calculated either monthly or annually.

Calculating compound interest annually

Add 1 to the rate of interest which is usually a decimal.
To this value put the power of the tenure of your loan or the number of years you want to have your savings for.
Multiply the result that you get with the principal amount or the current balance of your account.
This will give you the new balance that you will have in your account.

The formula used for compound interest per month is:

Principal x (1+rate of interest) ^tenure

Calculating compound interest monthly

Divide the interest rate by 12. This is because interest rates are usually expressed for the whole year.
Add 1 to the number that you get to denote the compound interest.
To the value that you get, put the power of the tenure of your loan.
Multiply the result that you obtain with your principal amount or your current balance to get a new balance.

The formula for the compound interest calculated monthly is as follows:

Principal x (1+rate of interest / 12) ^tenure

To help you calculate your compound interest easily, you have the option of using an online compound interest calculator. In order to calculate your compound interest, all you have to do is enter the rate of interest offered on your savings account or levied on your loan, the tenure of your loan or the time that you wish to put away savings for and the principal amount.

These compound interest calculators also allow you to calculate the principal amount, rate of interest and the tenure of investment or loan in advance. That way, you know how much you need to invest to get a sizeable return or the tenure that you need to invest it for. You are also able to calculate the expected repayment amount so that you can plan your finances accordingly.

Understanding compound interest is quite simple. Once you know a few facts about compound interest, you will be able to use it well to your advantage to increase your savings and to also manage your repayments towards your loans and other borrowings better.

Here are some facts about a compound interest that you should know if you are thinking of making any important financial decisions in the future:

The benefits of compound interest are for everyone: If you are able to invest wisely, you can make the most of compound interests irrespective of your current financial situation, employment status, and so on. The only thing that you need to know with compound interest is that as long as you are able to leave a portion of your earnings in your account, you will be able to gain from it over a period of time.
There is a flip side to compound interest: With most loans and borrowings, compound interest can be a bad thing. As far as savings are concerned, you are only going to gain from compound interest. However, with borrowings, especially with credit cards, the concept of compound interest leads to larger repayments. As mentioned before, the interest charged on any outstanding balance on your Credit Cards can pile up in no time if you are being charged a compound interest.
It actually adds up faster than you can imagine: Now, even a small saving per month can multiply by a lot over a period of time. This also includes periods when you may not add any money into your savings as the interest is being added automatically to the principal amount. This is true for all your debts as well. The lesser you repay, the more it will compound, leaving you with a bigger debt than you started out with. With savings, make sure that you retain your money for longer, and with borrowings make sure that you repay as much as possible when you are compounding.
Time is an important factor in compounding: When compound interest is applied to your savings, the longer you save and compound, the better it is for you. If your wealth is growing at 6% per year, then with compound interest, you will have double the amount in about 12 years and will have about 4 times the amount in 12 years. Contrary to this, when it comes to loans and borrowings, the faster you repay, the better it is for you. These open-end accounts tend to use compounding against you. So, if you continue to make minimum repayments, the chances are that you will be in debt for much longer than you could expect.
The more often the savings compound, the better it is for you: In the case of savings, it is better that you plan to compound monthly or quarterly as opposed to annually. This means that your principal amount increases steadily if you are compounding more often. However, when it comes to loans the less often you compound the better it is. This is because the amount repayable increases when you are compounding more frequently, making it pile up extremely fast.
Low-interest rates should not disappoint you: You do not earn very high rates of interest when it comes to savings accounts in most banks. So, it may seem like a mutual fund or another investment option is better than putting your money away in a savings account. They provide higher interest rates and also have low minimums and do not have sales charges either. However, if you are not able to apply a part of your wealth into savings, your debts will also let you add any amount that you want for payments.
Compound interest can actually make repayments faster: Let us say you start out by repaying the minimum amount towards the Credit Card balance and increase the amount each month. With compound interest, you will be able to avoid a huge chunk in payment over a period of time, provided that you make stable and regular increments in your repayment amount.
Compound interest is a safe way to secure your future: Choosing a savings account with a lower interest rate can seem like a large sacrifice, especially with other investment options available. However, this saving option is completely risk free and is suitable for just about anyone.