Compounding
In finance, compounding describes the method for calculating interest on a loan, sometimes called “interest on interest,” in which interest is paid not only on the initial principal amount of a loan but also on the accumulated interest from previous periods. This can significantly increase the cost of a loan over time.
In a simple interest scenario, interest is only calculated on the original principal amount. With compounded interest, the interest for each period is added to the principal, and future interest is calculated on this larger amount, which includes the previously accumulated interest.
In the case of loans, compounding works against the borrower. The more frequently the interest is compounded, the more interest accumulates on the loan, increasing the total amount that must be repaid.
Financial Glossary
Use Lighter Capital's glossary to understand common terms used in finance and investing, so you can build financial literacy and make informed decisions for your startup.
Compounding
In finance, compounding describes the method for calculating interest on a loan, sometimes called “interest on interest,” in which interest is paid not only on the initial principal amount of a loan but also on the accumulated interest from previous periods. This can significantly increase the cost of a loan over time.
In a simple interest scenario, interest is only calculated on the original principal amount. With compounded interest, the interest for each period is added to the principal, and future interest is calculated on this larger amount, which includes the previously accumulated interest.
In the case of loans, compounding works against the borrower. The more frequently the interest is compounded, the more interest accumulates on the loan, increasing the total amount that must be repaid.
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