With simple interest the amount of money borrowed remains fixed.
For example is borrowed for three years at an interest rate of per annum.
(per annum means each year)
Interest for one year
Interest for 3 years =
You can write this in an expression:
(principal) is the amount borrowed.
is the rate of interest per year.
is the time in years.
Here the interest is added to the principal at the end of each year. So the next year the interest is worked out on a larger amount of money than what was originally borrowed.
This means paying interest on the interest of previous years (unlike simple interest, where you only pay interest on the original amount).
This is how it is calculated:
is borrowed for three years at compound interest.
Principal at the start
Interest in the 1st year
Principal after 1 year
Interest in the 2nd year
Principal after 2 years
Interest in the 3rd year
Principal after 3 years
The total interest charged under compound interest will be .
This is different to the simple interest worked out above.