When taking a loan, a borrower has the privilege of using somebody else’s money, for which they pay a certain interest. The interest is calculated as a percentage of a loan amount paid to a lender with the agreed periodicity. It is typically calculated for a year, but it might also be longer or shorter.
For instance, if a lender is lending $100 to a borrower at a simple interest rate of 3%, the interest amount (interest charge) will be $3 per year.
In the case of compound interest, that is, the interest earned from the original principal plus accumulated interest, the situation will be different. Based on the previous example, a borrower will have to repay $3 in the first year. If they use compound interest, in the following year, they will have to repay 3% of the first-year balance, which is $103, which results in $3.09 in this year. The balance at the end of the year will be $106.09. In the third year, a borrower has to repay an interest rate on the previous year's balance, which will be $3.1827.
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