How To Calculate Compound Interest
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Written by: NoahJames
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Date: Fri, 7 May 2010 |
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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.
If you had a loan with a monthly interest rate of one percent, the annual rate would work out at around 12.68 percent, due to the effects of compound interest. The annual rate is often called the Annual Equivalent Rate (AER) or the Annual Percentage Rate (APR).
The advertised annual rate of any financial product usually includes any additional bonuses or charges as part of the percentage. For instance, if you had to pay a fee up front to take out a loan of a certain size, this fee would be calculated into the APR.
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 effects of compound interest can make it tricky to work out exactly how much a mortgage is likely to cost, and whether you will be able to afford it or not. However, you can get a rough idea by using an online mortgage calculator, such as the one on the Alliance and Leicester Website.
Calculating a mortgage involves a fair bit of complicated mathematics, and can take a fair bit of time and effort to do on your own. Thankfully, mortgage calculators do all the hard work for you, enabling you to quickly compare and contrast different mortgage deals based on the data provided by the lender.
About the Author
Delmer Fernow is the author of this article. Alliance and Leicester have a great mortgage calculator solution available.
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