What is compound interest?

By Caitlin in Money
What is compound interest?

Do you feel like your debt is spiralling out of control? Are you having trouble focusing on anything because you’re constantly worried about how much money you owe? If this is currently how you are feeling you need to start educating yourself about the risks of unpaid debt and how compound interest is exacerbating your debt problems. We fully believe in your ability to get your debt under control but it’s going to take some hard work so the more you know about the ins-and-outs of debt and compound interest the better chance you have at succeeding.

Compound Interest: What You Need to Know

Compound interest is the interest that you’re charged on your principal debt (so the amount of money you actually borrowed or spent) and on any previous interest you were charged. You can be charged interest, depending on what type of credit or loan you have, per day, per week, per month or per year. Compound interest adds up quickly and you’ll end up paying back significantly more than you borrowed originally. (Click here to learn more about APR and AIR)

Here is an example to help explain how compound interest works on a loan. If you take out a $10,000 loan and your annual compounded interest rate is 10%, in the first year you’ll pay $1,000 interest but in the second year you’ll pay $1,100 in interest. The amount you owe in interest each year will continue to grow until you are able to pay off the loan in full, but with compound interest this can take a long time and a lot of money. Simply put, the longer it takes you pay off the loan the more money you’ll end up paying. This is of course an extremely simple example, all interest rates, compounded or not, rely on several variables including you, your lender, as well as the regularly scheduled payments that typically come with a loan.

How Quickly Can my Debt Get Out of Control?

It’s impossible to say exactly how long it will take for anyone’s debt to get out of control, but the one thing we can say is that it often happens a lot quicker than most people think and more often than not when they least expect it. Compound interest, simply put, makes money for the lender or creditor. Unfortunately it’s almost impossible to avoid compound interest as it’s the standard in the financial world. Since you can’t avoid compound interest you need to learn to handle it appropriately.

  • Know how frequently your interest accumulates (does it accrue daily, weekly, monthly or yearly?)
  • Always no matter what, make your payments on time
  • Fully understand the terms and conditions of your loan
  • Figure out if you can make accelerated payments or extra payments

Depending on your interest rate and the terms of your loan, it is possible for your debt to get out of control quickly. The most important thing you can remember is that the money you spend or borrow is never equal to the actual amount you’ll end up paying in the end.

Help! My Debt is Already too Much to Handle

If you’re already experiencing debt problems do not panic, there are a few steps you can take right way to start dealing with the issues and get your debt back under control.

  1. First thing you need to do is create a budget for yourself, this will allow you to see how much money you’re bringing in and how much you’re spending.
  2. Once you have a solid budget in place (one that you can actually stick to), you should take a closer look at your debts. You need to prioritize them based on interest rate and amount owed.
  3. Debt with a high compounding interest rate needs to be paid off first and quickly.
  4. Think about debt consolidation as an option. You’ll be able to combine all your debts into one manageable payment and potentially pay a lower interest rate, which may help you become debt free quicker.
  5. Finally, if you’re at the point where you know you need help, ask for it. Trying to avoid seeking the help you need will only prolong the process and potentially even make your current debt situation worse.

Get The Relief You Want

Compound interest is a scary thing, especially when it becomes too much for you to handle. It accumulates before your eyes and makes your previously manageable debt, unmanageable. If you are currently feeling overwhelmed we want you to know that there is help out there. So get out there and ask for the relief you need before it’s too late.


All consultations and conversations with Loans Canada and its partners are confidential and risk-free. Speak with a trusted specialist today and see how we can help you achieve your financial goals faster.

Loans Canada and its partners will never ask you for an upfront deposit, upfront fees or upfront insurance payments on a loan. To protect yourself, read more on this topic here.