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Grasping Compounded Interest Rate

Grasping-Compounded-Interest-Rate-FastAccessFinance -- Unsecured Personal Loan

There’s a reason why banks and lending firms in Australia offer various financial instruments and facilities to individuals and businesses. By offering loan facilities, they (banks and lending firms) make their earnings from the interest rates they charge to borrowers.

The most common type of loan availed by many Australians is the personal loan. This can be secured or non-secured personal loan. Secured personal loan requires collateral while non-secured personal loan has no such requirement.

Personal loans may also be charged with different types of interest rates: fixed rate, variable rate or compounded interest rate.

Interest rates are set by the Reserve Bank of Australia (RBA) – the nation’s central bank. The set rate of RBA determines the interest rates for the different types of loan facilities as well as for bank deposits. Members of the RBA board meet once a month to examine the latest inflation rate, employment, economic growth, home loans, expenditure on consumer goods and building activity. Higher interest rates discourage people from borrowing which will slow economic activity as well as inflation.

What is Compounded Interest Rate

By definition, compound interest is the interest earned on previously accumulated interest plus the principal amount. This can be best understood in two stand points: the borrower and the lender (investors).

Borrower

If you take out a personal loan and the bank charges you for the borrowed money with compounded interest rate, it means that if you are not able to fulfill your loan repayments on the due date, the interest is added to the unpaid amount which already included the interest. In the end, you are compelled to pay interest on the interest. The best example of how compounded interest rate works on loans is the credit card debt. If you are unable to pay your credit card balance in full every month, the interest, calculated daily is added to the amount you owe. This is disadvantageous to the borrower because the owed amount rises.

Lender (Investor)

From the standpoint of the lender, compounded interest provides them with a quick way to grow their investment. If they invest $100 expecting to earn on 10% interest per annum, after a year, their investment will have become $110. If the investor does not take the money out, the total amount of $110 will earn 10% interest for another year, which is $11, making the total money invested after the second year to be $121. The next year, the 10% interest rate will be applied to $121 making the interest amount to be $12.10 and the total investment amount will be $133.10, after three years. This continues until the end of the investment term or until the money is withdrawn.

 

Posted in : Finance Guide
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