Compound Interst

 

What is Compound Interest?

Compound interest is when your interests earns interest.  Okay, what does that really mean?  Lets say you put $1,000 into your bank account that pays you 5% annually.  

By the end of the first year you would have $1,050!  That's great right?  Well, if you leave that amount alone and continue to earn 5% you will have $1,102.50 at the end of year two.  Say what?  

Isn't 5% of $1,000 = $50?  Yes, however, you are now earning interest on your original amount plus the interest you earned in year one.  Hence, compound interest!

Is Compound Interest Good or Bad?

Compound interest is great when you are earning it in your account.  However, this is also how credit cards make money too.  If you don't pay off your credit card each month you are paying the credit card company compound interest on your purchases.  This is a trap that some people get into which causes them to get into a debt spiral and they end up paying way more for the items they charged to the card then what they would have paid if they used a form of cash.

Conclusion

Earning compound interest is good.  Paying your credit card company compound interest is bad!  If you can not afford paying cash for your items you should reconsider if you can actually afford the item.