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When you invest money or take out a loan, compound interest could have a powerful snowball effect. Learn how in the MoneySense Glossary.
Compound interest means that a stated interest rate will be applied to both the original amount invested or borrowed and the accumulated interest earned or unpaid. The interest is compounded at a set frequency—daily, weekly, quarterly or annually.
For investments, this creates a snowball effect that can help your savings grow faster, as you earn interest on your original investment and the interest it earns. For unpaid loans, however, that same snowball effect makes your debt grow faster, as the lender will charge interest on the amount borrowed and any accumulated interest.
Example: “Rhonda pays $20 towards her credit card debt each month, but because the issuer charges 20% interest compounded monthly, her $1,000 debt will take more than nine years to repay, with interest payments adding up to more than the original $1,000.”
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