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What is SIMPLE vs. COMPOUND INTEREST

Interest Rates

LET’S TALK ABOUT SIMPLE vs COMPOUND INTEREST

Learn about Interest

LEARN ABOUT INTEREST TYPES

he total American household debt hit a record high at $13.21 trillion in 2018. This debt is spread out over millions of people and several different types of loans. Americans have loans for education, cars, homes, and even lawsuits. One thing all of these loans have in common is that they charge interest. It is important to know the difference between Simple vs Compound interest.

When obtaining any loan, it’s essential to look at the terms and know what you’ll agree to. Compare lenders and the simple interest vs. compound interest terms offered.

If you aren’t sure what the difference is between these two types of interest, we’re here to help with this simple guide.

WHAT IS INTEREST?

When you approach a lender about borrowing money, you agree to pay back more than what you originally borrowed. This extra money gets determined by calculating a percentage of the total amount borrowed. You’ll hear this referred to as the interest rate.

Lenders can calculate the interest using two different methods,or in other words simple vs compound interest.

Simple Interest

The simple interest method requires the lender to only use the original loan amount to determine the amount of interest owed. When comparing simple interest lawsuit loans, you’ll be able to easily multiply the percentage by the amount borrowed to

LOOK FOR SIMPLE INTEREST RATES

determine the total amount of interest owed.

Compound Interest

When calculating compound interest, the lender will use the total amount borrowed plus any accumulated outstanding interest to determine the additional interest owed. Any interest still owed gets added to the original amount borrowed, and then the new total is used to calculate the new amount of interest owed.

SIMPLE INTEREST vs COMPOUND INTEREST EXPLAINED

There are a few critical differences between simple vs. compound interest that can help you understand your potential liabilities. When you apply to lenders, look for one of these two terms to understand the full scope of the loan offered.

Principal Amount

For simple interest pre settlement loans, the principal amount owed remains the same for the entire life of the loan. For compound interest loans, the principal amount will change every time the interest gets compounded.

Lender Return

Simple interest is more favorable for borrowers as it results in a lower overall return for the lender. Compound interest is desirable when you’re looking to invest your money, but isn’t as beneficial when you’re taking out a loan. With compound interest providing a higher return to lenders, you’ll end up paying more than you need to.

Growth of Total Owed

You can expect your total debt owed to grow at a constant pace with simple interest. The principal amount will stay the same, and the interest owed accumulates at a steady percentage pace.

While a compound interest loan will also accumulate at a consistent rate, it’s an increasingly faster rate. As the principal amount

Interest Calculation

CALCULATE YOUR INTEREST CAREFULLY

accumulates, the total interest calculated will rapidly increase over the life of the loan.

Calculation of Simple Interest

You can calculate the interest for your loan by using this formula.

P x R x N= I

  • P= Principal
  • R= Rate
  • N= Number of years
  • I= Interest owed

If you took out a 5-year loan for a total of $10,000 with an interest rate of 5%, then you’ll pay $2,500 in interest over the life of the loan.  The total amount you’ll repay is $12,500.

$10,000 x .05 x 5= $2,500 Interest

$10,000 + $2,500= $12,500 Total Repaid

Keep in mind that this is just one piece of the loan puzzle. You need to understand how the entire loan works to ensure you satisfy all of the lender’s requirements.

For example, settlement loans require you to have an open case where an attorney represents you. A car loan requires that you use the money to purchase a car where you give the lender a claim to the title.

Calculation of Compound Interest

The formula for compound interest is a little more complicated.

P x (1+R) ^NK=I

  • P= Principal
  • R= Rate
  • N= Number of years
  • K= Times of compounding
  • I= Interest

The first thing you’ll notice is that the element of time is added to the equation. The amount of interest owed will vary significantly based on how often the interest gets compounded. The lender can decide to compound the interest as often as they like, but there are a few common intervals.

  • Annually- once per year
  • Quarterly- 4 times per year
  • Monthly- 12 times per year
  • Weekly- 52 times per year
  • Daily- 365 times per year
Decision Making

MAKE A GOOD DECISION

Let’s use the same example as above, $10,000 original loan amount on a five-year loan at a rate of 5%. After five years of yearly compounding interest, the total amount you’d owe is $12,762.82. As you can see, you’ll pay an extra $262.82.

$10,000 x (1+.05)^(5*1)= $12,762.82

But now consider if the lender compounds the interest monthly instead of yearly. The total amount owed after five years increases yet again to $12,833.59. The more often the lender compounds the interest, the more interest you’ll end up owing.

$10,000 x (1+.05)^(5*12)= $12,833.59

DETERMINING THE INTEREST RATE

One area where simple and compound interest rates are similar is how they’re determined. The US Treasury notes and bonds and the bank industry influence long term and fixed interest rates.

These are guidelines that create a range that most lenders will fall into. Ultimately the exact interest rate and how it gets calculated is up to the lender to decide on.

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When you start comparing lawsuit loans, you need to consider simple interest vs. compound interest. You will find that the total

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amount you owe can vary widely depending on whether you choose compound vs. simple interest.

Simple interest is the best option when looking to borrow money. Compound interest is better when you’re looking to invest and grow your wealth.

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