Compound interest is that interest that is calculated in turn on the interest previously generated on the initial balance. In other words, the interest that is not paid within the maturity period is capitalized and generates further interest called compound interest. This results in higher interest payments over time if the balance is not paid within the first compounding period.
Steps
Step 1. Find the "period rate" of your compound interest
This is the rate at which your interest is compounded, divided by the number of times it is compounded in a year. For example, if you have an annual interest rate of 12.99% and compounding occurs monthly (i.e. 12 times a year), the period rate calculation will be 0.1299 / 12 = 0.011.
Step 2. Add 1 to your "period rate" value
In our example, this is equal to 1 + 0, 011 = 1, 011.
Step 3. Take the value you just calculated and raise it to "m"
The "m" represents how many months have passed since the opening balance. In our example, if 3 months have passed, we will raise the previously calculated value to the third power; therefore, 1.011 ^ 3 = 1.033.
Step 4. Subtract 1 from the total value you just calculated
In our example, it is equal to 1 - 1, 033 = 0, 033.
Step 5. Multiply this value by the amount of the opening balance
Let's suppose that in our example the starting capital is equal to 2,500 euros. Then, we would get 0.033 x 2,500 = 82.5. The resulting number represents the amount of compound interest payment that accrued during the months that the opening balance generated interest rates at that specific interest rate. In our example, over the 3-month period, with an interest rate of 12.99% compounded monthly against an initial balance of 2,500 euros, the compound interest generated amounts to 82.50 euros. So, to bring the balance back to its initial value, you would have to make a payment of 82.50 euros.
Advice
- Percentages are always calculated in decimal figures. To find the decimal amount of your specific interest rate, simply divide it by 100. For example, if your interest rate is 12.99%, in decimal it is 12.99 / 100 = 0.1299.
- To calculate the total balance amount after a certain amount of months has passed since the starting balance, take the compound interest value calculated with the steps above and add it to your starting balance. In our example, the value would be 82.50 + 2.500 = 2.582.50 euros of total balance, including compound interest accrued in 3 months.
- When using this formula to calculate compound interest for periods greater than one year, be sure to enter the amount of months that have elapsed since the opening balance and not the amount of years. For example, if 3 years have passed since the opening balance, you must enter the value of 36 months in place of the "m" in the formula.
- If you don't have a calculator that has the ability to raise a value to the power "m", just multiply the value by itself by "m" times. In our example, you would have to multiply 1,011 by itself 3 times and then 1,011 x 1, 011 x 1, 011 = 1,033.
