Definition:
Interest that is charged on the total value of the principal plus the interest which has already accumulated and been capitalized. Compound interest is contrasted with simple interest, in which interest is charged only on the original principal. For example, a bank charging a simple interest rate of 10% annual rate on a $10,000 loan will charge you $1,000, but if they charge 10% compounded quarterly then the charges will be higher because the interest that accrues each quarter (charged at 1/4 of the annual rate) is added to the principal, and then interest is charged on that new total in the next quarter, and the process is repeated for each subsequent quarter. The $10,000 principal in the first quarter becomes $10,250 in the second quarter, $10,506.25 in the third quarter, and so on, resulting in an annual interest payment of $1,038.13 for the first year. In order to pay off the loan on time, payments must be greater than the accrued interest or the borrower will face negative amortization.
