What is Compounding Interest?

Componding Interest

Componding Interest

Compounding Interest is an often times misunderstood and overlooked way to figure an interest amount that the consumer needs to pay back to the lender.  The actual definition of Compound Interest is: the concept of adding accumulated interest back to the principal so that interest is earned on interest from that moment on.  An easier way to say this is that your principal loan or credit amount is getting larger from the first month on if you make minimum payments and thus making your payments larger if you don’t pay them off quickly.

The lenders normally give a low interest rate to make it look more appealing to the consumer.  For example, a principal loan amount of $100.00 with a compounding interest of 1% (seems like a low rate, doesn’t it?) will have a principal loan amount of $101.00 at the end of the month.  For the sake of discussion, let’s say your minimum payment is only $2.00 which you make at the end of the month.  That reduces your principal amount to $99.00 instead of $98.00 because now the principal amount is $101.00 instead of the original $100.00 that you put on credit.  Now, the second month your original $100.00 purchase price is still up to $100.00 even though you made a minimum payment of $2.00.  You can see how this will keep going much longer than is necessary if you would have bought that item with a different payment arrangement.

Many of us would just keep making that normal payment cycle and not even think twice about it while someone that is keeping up with all of their payments on a budgeting program such as Easy Budgeter would have noticed it before they even agreed to it.  That is money they are saving while the rest of us are spending it.

Do yourself the favor and start a solid budget program and stick to it each and every month.  You’ll find money at the end of the month that you didn’t even know you had.

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John Mills

Independent Reviewer