The amount of money that a borrower pays to a lender for the usage of borrowed funds is referred to as interest. The borrower must repay the principal amount borrowed plus interest, which is usually computed as a percentage of the principle.
Compound interest, on the other hand, is interest computed not only on the initial amount borrowed but also on any interest that has accrued over time on that principal amount. This implies that as interest accumulates, so does the interest earned in succeeding periods.
The formula for calculating compound interest is:
A = P(1 + r/n)^(nt)
Where:
A = the final amount
P = the principal amount
r = the annual interest rate (as a decimal)
n = the number of times interest is compounded per year
t = the time (in years)
For example, if you invest $1000 in a savings account with a 5% annual interest rate, compounded monthly, for five years, the calculation would be:
A = 1000(1 + 0.05/12)^(12*5)
A = 1000(1.004167)^60
A = $1283.05