Simple and Compound interest

ntroduction

If you have a savings account with a bank and deposit some money, the bank will pay you extra money for saving with them. Similarly if you need to borrow money from a bank the bank will expect you to pay back more than you borrowed from them in the first place! How much extra depends on theinterest rate set by the bank. Banks make their money by charging more for their loans than they give for their savings accounts.

For your GCSE maths exam you need to know about two different types of interest rates, simple interest and compound interest.

Simple interest is where the amount of interest earned is fixed over time. For example, if you saved £1000 at 4% simple interest you would earn £40 per year, every year. The amount of interest earned stays the same when dealing with simple interest.

Compound interest is where interest is paid on the amount already earned leading to greater and greater amounts of interest. For example £1000 at 4% compound interest would earn you £40 in the first year but in the second year you would earn 4% on the new amount of £1040 which would be £41.60.

Compound interest is by far the most common…