JagInsights › Lessons › Compound interest
What compound interest does to savings and to debt
The slogan is 'interest on interest.' The useful version is: leaving money in, or leaving interest unpaid, changes the base the rate applies to next time.
On savings, compounding grows the balance if you leave the interest in. On a card you do not pay off, unpaid interest is added to the principal and the APR applies to a larger number. A calculator rate is an input, not a promise.
A $1,000 example, written out
One thousand dollars at 10 percent a year, compounded once a year, is $1,100 after year one and $1,210 after year two (1,100 times 1.1). Simple interest at the same 10 percent would have added $100 each year and landed at $1,200. The extra $10 is interest that itself earned 10 percent. The 10 percent is arithmetic, not a quote of anyone's savings APY.
More frequent compounding (monthly, daily) credits interest sooner, so it can start earning sooner. APY is how savings products fold that into one yearly number you can compare.
Time is the lever, not a personality trait
Starting five years earlier usually beats saving a slightly larger amount later, because those first dollars get more cycles. That is math on a spreadsheet, not a verdict that someone who starts later has failed.
The Rule of 72 is a classroom shortcut: 72 divided by the yearly rate estimates years to double. At 6 percent, 72 divided by 6 is about 12 years. It is an estimate, not a contract.
The same math on a balance you owe
A card APR compounds on unpaid interest. That is why a minimum payment that barely covers the month's interest leaves the balance almost still. Paying in full stops the base from growing.
A certificate of deposit can pay more in exchange for locking the money. If you might need the cash next month, that lock is a cost. Compounding does not make a CD an emergency fund.
Questions people ask
Is a 10 percent return guaranteed?
No. The example is so the shape is visible. A real account can return less, or lose money.
Does compounding work on a savings account?
Yes, at that account's APY, which is often much lower than a long-run stock example. The math is the same. The rate is not.
How is this different from APR?
APR is the stated yearly rate on a debt. Compounding is what happens when unpaid interest is added to the amount that rate applies to.
Educational information only. JagInsights is not a financial adviser, broker, or lender. See the Terms and Privacy Policy.