Compound interest – two words that pop up regularly when it comes to loans and credit cards. But what does it actually mean? We break it down…

What is compound interest?

Compound interest is the interest you’re charged on the amount of money you owe, along with any interest which hasn’t been already paid off from previous months. Basically, it’s interest charged on the loan and previous accumulated interest.

For example:

Say you borrowed AED 100 from a bank at a 10% monthly interest rate.

If at the end of the 1st month you paid NO money off the loan, you would be charged 10% of AED 100 taking your overall loan amount to a AED 110.

Then…If at the end of the second month you still hadn’t paid any money off of your loan, you would be charged 10% of AED 110 taking your total loan up to AED 121.

This would then carry on in the same way every month, with the amount you owe continuing to increase by a larger amount for each month you don’t pay anything off your loan.

The danger:

Failing to pay off any amount from a loan would mean the interest added would grow at a fast rate, resulting in the amount of debt you need to pay off having increased substantially.