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Compound Interest Formula

Compound Interest Calculation

Last Updated 20th Jan 2021

  • The compound interest formula is applied on debts and investments whereby the interest is calculated not only on the principal loan or invested amount but also on the accumulated interest.
  • Investments with compound interest earn higher interest than investments with simple interest.
  • Compound interest can be calculated on a daily, monthly, quarterly, half-yearly or yearly basis depending on the bank's or the lender's compounding frequency.
  • Higher the number of compounding periods, higher will be interest generation.
  • Compound interest can be calculated accurately by using an online compound interest calculator.
  • This formula can be applied on various investments as well as debts such as savings account, recurring deposit, fixed deposit, certificates of deposit, credit card, mortgage and other loans, etc.
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What is the Compound Interest Formula and its concept?

A compound interest formula is a financial tool that helps in wealth generation. Investments made with compound interest generates higher returns than investments with standard returns. Under this interest computing formula, interest is added on both the principal amount of a loan or investment and the interest earned from the previous periods. In the first period, the principal sum accumulates interest. However, from the next period, the principal sum and the interest accrued till the respective period generate interest. Thus, this method provides interest on interest.

The rate at which the given interest is compounded depends on the frequency of compounding. The higher is the number of compounding periods, the higher will be the interest amount. The part can be compounded daily, monthly, half-yearly, quarterly or even annually.

Compound Interest Formula with Example

Knowledge of how the formula works will help you to understand the benefits and make a correct decision. There is a simple formula that can help you in computing the compounded interest. The Formula is,

A = P(1+r/n) ^ nt

In this compound interest formula, 'A' stands for the total returns, 'P' stands for the principal amount invested, ‘r' stands for the annual rate of interest. 'n' stands for the compounding frequency per annum and 't' is the number of years elapsed after the initial investment.

Compound Interest Illustration: Suppose you made an investment of ₹ 30,000 for a time period of 10 years with an interest rate of 5% per annum, compounded annually. The compound interest calculation for the first year will be done using the following formula:

Principal amount * rate of interest/ 100

In this case, the compound interest for the first year will be:

30,000 * 5/100 = ₹ 1,500

Under the compound interest tool, the interest for the second year will be computed on the principal sum plus the interest compounded in the first year, that is,

₹ 30,000+ ₹ 1,500 = ₹ 31,500

Thus, the compound interest after the second year will stand at:

31,500 * 5/100 = ₹ 1,575

In a similar way, for the third year, the interest will be calculated on ₹ 31,500 + ₹ 1,575 = ₹ 33,075 and the compound interest will be calculated by the same formula used to calculate the first year's interest. This calculation process will continue for ten times as the investment tenure is ten years.

You can also calculate the final amount of deposit by following the formula mentioned above, that is,

Maturity amount = P(1+r/n) ^nt = 30,000(1+5/12)^12*10 = ₹ 1,96,03,488

Compound Interest Calculator - Calculate Compound Interest Online

You can use an online compound interest calculator to get a precise idea of how much your investment or debt will multiply into at the end of a specific tenure. The compound interest calculators available online gives you the option of calculating the interest for various compounding frequencies such as daily, monthly, quarterly, half-yearly and yearly. You will have to provide the required information for calculating the compound interest such as the principal amount, rate of interest, time period in years and the compounding frequency. After providing these details, you can get accurate numbers.

There are many benefits of calculating the compound interest using an online compound interest calculator.

  • Online calculators will show the exact amount of return that you should expect at the end of a specific period. Thus, there is no chance of making a calculation mistake while planning to invest your hard-earned money.
  • It gives you a clear picture of how much investment you might need to make in order to get the desired return at the time of maturity.
  • With an online compound interest calculator, you can not only calculate the total returns but also calculate not only the total return case you plan to break an investment before maturity.

Financial platforms where compound interest is applicable

Several financial platforms use the compound interest formula for calculating interest. Some of the investment and loan options where compound interest is applicable are:

  • Savings Account: Saving accounts offer compounding interest on daily, monthly or quarterly frequency. You can make contributions to, or withdrawals from your savings account as you require and the compound interest will be calculated on balance at the end of the compounding interval.
  • Fixed Deposit: The interest is generally compounded quarterly in a fixed deposit. The interest compounded on the deposited amount in the first compounding period will generate interest along with the principal amount in the next period.
  • Recurring Deposit: The compound interest is calculated on a quarterly basis in a recurring deposit. You get to deposit a predetermined amount every month in the account, and the interest rate is the same as that in a fixed deposit. If any monthly deposit is delayed, the total compound interest payable in the deposit will be reduced as a penalty.
  • Loans and Mortgages: The interest on loans and mortgages that have an EMI or monthly instalment option for repayment is often compounded on a monthly basis. Thus, the total interest to be paid by the borrower is higher than loans with simple interest. To find out the total compound interest that you will need to pay on your loan, you have to divide the interest rate offered by the number of payments you will make in a year and then multiply the same by the balance of your outstanding debt.
  • Credit Cards: Most credit card issuers compound interest on a daily basis. However, they mention the credit card's interest rate annually. For compound interest calculation on credit card bills, firstly you need to convert the APR or the Annual Percentage Rate into a daily interest rate by dividing the APR by 365. Then, you have to find your average daily balance and divide it by the duration of your billing cycle. Finally, you can get the compound interest amount by multiplying your average daily balance by daily interest rate and then again multiplying the total by the number of days in your billing tenure.

FAQs

Is it better to have interest compounded daily or monthly?

The quicker the interest gets compounded, the higher will be the total amount of interest accumulated. Thus, as an investor, it will be wiser for you to invest in a deposit which compounds interest on a daily basis than going for a deposit compounding interest monthly. On the other hand, if you are a borrower, you will have to pay a higher amount of interest if your loan amount is compounded on a daily and not a monthly basis. So, whether having interest compounded on a daily basis is better than a monthly basis or not depends on whether you are investing or borrowing.

What is the formula for daily compound interest?

You can find the daily compound interest amount by following any of the two formulas given below:

  • [Principal sum {1 + (rate of interest / 365)}^ (number of years * 365)] – Principal amount
  • [Principal amount(1+interest rate)^ number of years] -Principal amount
    After your investment matures, you can simply calculate the compound interest earned by subtracting the principal amount from the maturity amount.

What is the best compound interest?

Compound interest can be calculated daily, monthly, quarterly, half-yearly or annually, depending on the type of deposit and your banks compounding frequency. As an investor, you must look for investing your money in a bank which compounds interest more frequently as a greater number of compounding periods will fetch a higher compound interest on your investment. If you are taking on debt, it s better to go to a lender who will compound the interest less frequently on your loan amount as then you have to pay a comparatively lesser amount of compound interest.

What does it mean if the interest is compounded daily?

If interest is compounded on a daily basis, it means that the interest is added to your principal amount at the end of every day. So the principal amount increases every day from the second day of investment. In this case, the total interest accumulated over a period is higher than in case of any other compounding frequency.

Do any banks compound interest daily?

Compounding interest on a daily basis on your investment can help you earn huge returns. There are a number of banks where interest is compounded on a daily basis on savings deposit. Some of these banks are Ujjivan Small Finance Bank, Ratnakar Bank or RBL Bank, DBS Bank, etc. However, most banks compound interest on a quarterly basis.


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