Compound Interest: Compound Interest Rate Formula

Interest Rates - (on November 17, 2015 03:33 AM)

Compound interest rate is virtually important topic to understand both for savers and borrowers, in simple term it is block building concept against actual money and how it works we will guide you with simple example.


Compound Interest Rate Formula


 The formula for annual compound interest is A = P (1 + r/n) ^ nt:



A: is future value of the investment/loan (including interest)
P: Is principal investment (initial deposit or loan amount)
r: Is annual interest rate (in decimal)
n: Is number of years that interest is compounded
t: Is number of years the money is invested or borrowed for



Let’s suppose that you had $2000 deposited in a saving account of any bank or financial institution and pay 5 percent (per annum) annual interest after tax. So that after the end of one year you have $2000 plus addition of $100 amount of interest (5% of $2000). Now your total amount is $1100. Simultaneously at the end of second year you will earn another $100 on original amount $100, now further interest will be calculated on $100 which is $10 earned.


It means every year interest of 5% will be added in actual amount and after addition of previous year interest amount as we elaborated in the example. After this you will earn $210 after the end of second year.


After the passage of third year earning interest on the interest of year two and interest on the interest on the interest from one year.  We hope you will understand the complexity of compound interest rate calculations. In simple words money will grow more quickly because you will not only earn the interest on original amount but also earn interest on interest.

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