Got a loan or deposit? Compound interest calculator explained

Rainy day funds are essential, and earning interest is a fantastic and easy way to give them a boost. But how do the banks calculate your interest payments?

Simple: it's compounded!

But in case you're not a mathematician or banking expert, we've broken down how to work out your compound interest payments on your own – which can make comparing high interest savings accounts just that much easier.

(Psst: here's our guide for finding out how much interest you're paying on a home loan).

What is compound interest?

Whenever you put money away in a bank, the bank will pay you interest (usually each month) in exchange for using your funds in their transactions. The most common type of interest on your deposits is compound interest, which is when the previous month's interest is included in your new balance. That way, you earn interest on your interest, not just your initial balance.

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 healthy.

HOT TIP: As a rule of thumb, any savings interest rate over 2% is definitely worth checking out.

The benefits of compound interest

Compound interest is 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.

FAQs

What's the difference between compound and simple interest?

Simple interest will only calculate interest based on your original balance. Compound interest includes previous interest payments in your balance.

For example, if you stash away $1,000 with a 2% simple interest rate, you'd only earn money on the$1,000.

But if you stashed that same $1,000 with a 2% compounding interest rate, you'd earn interest on the thousand plus whatever your previous interest earnings were. This can lead to bigger savings down the road, since your balance will grow. What is the compound interest formula? The compound interest formula is a simple mathematic equation that calculates annual compound interest on a lump sum (called your principal). In practice it looks like this: 'A' is the new total you'll get with compounded interest included. 'P' is the initial principal balance (i.e. the amount you deposit). 'r' is the interest rate expressed as a decimal (so 3% becomes 0.03). 'n' is the number of times interest is applied during a given period of time, and 't' is the amount of time periods that have occurred. So if your compound interest is calculated yearly, 'n' would be 1 and 't' would be how many years you're planning on storing your money for. How does compound interest work? Compound interest essentially means you earn interest on your interest. For example, say you have a bank account earning monthly compound interest. Every month, you'd get a new interest payment that increases your overall balance. The next month, your interest payments will be calculated using the new overall balance (original + interest). This way, you actually earn more money as time goes on. How do you calculate interest compounded monthly? To calculate how much monthly compound interest you earn, use the general compound interest formula but with moneys instead of years for the 'n' value. For example, if you were planning to lock away$1,000 in a 3 month term deposit with 3% interest p.a., these would be your plug-in values:

• P = 1000
• ﻿r = 0.03
• ﻿n = 3
• ﻿t = 1

Once you follow the order of operations, you'll get 'A', which will be the principal amount + the compound interest you earned during the term ($1,030.30). Compare high interest savings accounts - last updated 13 July 2024 Search promoted savings accounts below or do a full Mozo database search. Advertiser disclosure • Savings Account 5.35% p.a. (for$0 to $250,000) 4.75% p.a.(for$0 to $1,000,000) Yes up to$250,000

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Evlin DuBose
RG146
Senior Money Writer

Evlin is RG146 certified for Generic Knowledge and has become a leading voice in finance news since joining Mozo two years ago. She is regularly featured in Google's Top Stories alongside major publications like News.com.au and Yahoo Finance, and seasoned journalists. Despite being in the industry for just two years, she is Mozo's go-to writer for all things RBA and her research has been referenced by the Victorian Government. With a Bachelor of Communications degree from UTS, where she won the Dean's Merit Award and acted as the Director of Student Publications.

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