Compound interest calculator
Got a nice rainy day fund built up? It might look even nicer with the effects of compound interest. If you’re wondering how much you’re earning thanks to your compounding interest payments - or how much you might be with the right savings account - then read on for a rundown of how to work it out.
Or, if you’re looking to find out how much interest you’re paying on a loan, find out here.
What is compound interest?
We all know that when you put money away in a bank, you earn interest on it, usually each month. When you earn compound interest, the previous month’s interest is included in your new balance, so you earn interest on it as well. At first it might not seem like it makes a huge difference - but a high interest rate over a number of years can be a great way to keep your savings account looking plump and healthy!
The benefits of compound interest
Compound interest will grow your savings faster - which is a nice bonus from your savings account! It’s a more effective way of earning than simple interest, which only works on your initial deposit. For example:
If you had $25,000 in a savings account earning 4% simple interest p.a., you’d have $30,000 in 5 years.
If you had the same $25,000 in a savings account earning 4% p.a. compounding monthly, you’d have $30,525.
That’s $500 more in your pocket, and you didn’t have to lift a finger.
The flip side
While compound interest is great for your savings account, it’s not so good for loan repayments. For home, personal or car loans, your interest is built into the monthly repayments, so you don’t have to think about it, but with a credit card debt it becomes a little trickier. If you’re only making the minimum payments on your credit card balance, you’re not really getting anywhere as far as paying off the principal goes, and interest can compound quickly.
What you need to know
Ready to calculate your compound interest? There are a few things you should know first to make the process a bit easier.
How much have you saved?
You’ll need to know your initial deposit, or the balance of your savings account at present. This is what the amount of interest is based on.
How long will it earn interest?
Are your savings parked for the next five years? Ten? Or have you only stashed them away in a high interest savings account for a few months to give them a boost?
What is the interest rate?
Obviously, you’ll need to know your interest rate to work out how much interest you earn. The standard annual interest rate is probably the one you saw when comparing savings accounts, and that’s the one you’ll need. Be careful not to mix it up with introductory or bonus rates, but be sure to account for those in your calculations
How often will the interest be paid?
Interest will usually be calculated daily and be paid monthly or annually. You’ll see the effects of compounding as often as your interest is paid. If your interest compounds monthly, you’ll earn more, because it will be being calculated on a higher balance each month.
Will you make regular deposits?
Got a bonus at work? Or Aunty Jan might have sent you a cash Christmas present this year. If you find yourself with extra funds - or if you’re a savvy saver and put away part of your paycheck every week - and make a deposit into your savings account, that will give you a bigger balance and more interest.
Calculating annual compound interest
Mathematically challenged? Don’t worry, just head right on over to our savings calculator page to crunch the numbers. But if you’re determined to put your maths skills to the test here’s how you calculate compound interest:
1. Add 1 to your interest rate (expressed as a decimal)
2. This value is put to the power of the amount of years you want to leave your savings for
3. Multiply the result by the principal, or current balance of your account
4. You’ll have the new balance of your account
Here’s an example: If you put $10,000 away in a savings account to earn 3% p.a. for 2 years, the calculations to work out your compound interest might look like this:
And you could see that your compounded interest would be $609 for the two year term.
Calculating monthly compound interest
1. Divide your interest rate by 12 (interest rates are expressed annually, so to get a monthly figure, you have to divide it by the number of months in a year.)
2. Add 1 to this to account for the effects of compounding
3. Put all this to the power of the number of months your savings will be put away
4. Multiply it all by the principal, or the current balance of your account
5. You’ll have the new balance of your account
A little confused? Maybe an example would clear things up: If you took $10,000 at 3% p.a. as above, and put it away for the same two years, but with interest compounding monthly, you’d calculate the interest like this:
And if you look at the example above, you can see that by compounding monthly, you’ve made an extra $8.57.
How accurate is this?
We like numbers here at Mozo, but we’re not computers, and even we make mistakes sometimes. This is a tried and true formula for working out compound interest, but it will likely be a few cents, or maybe even a dollar or two, off the exact amount, because of things like rounding and good old fashioned human error.
When we put the above example through our savings calculator, which has all the benefits of being a computer and having it’s times tables hardwired in, it calculated the new balance as $10,618. And c’mon, it’s not exact, but that’s pretty close.