User:Kishanpatel07/sandbox

Compound Interest

When interest is compounding, it means that when the next interest period arrives, it takes into account the total balance, rather than just the principal. For example, a $100 loan at 5% interest compounded annually will accrue a balance of $105 after one year. The next year, however, instead of taking 5% of $100, the interest will be applied to the total $105, making the new balance $110.25. The next year the interest will be applied to that $110.25, and so on for the whole length of the loan. This is different from simple interest in which a consistent amount of money, derived from a percentage of the principal, is paid to the holder of the loan periodically.

Basiclly the same interest rate will be applied to an increasingly large balance, the growth rate will be exponential. This means that the difference between compounding interest and simple interest will be minor over a short time (in the above example, only a $0.25 difference after two years) but will grow more and more quickly as time goes on. This also means that compounding interest is more sensitive to high interest rates, since that will speed the growth even more, as well as extended time periods, which allow the balance more room to grow.