Whether borrowing or investing, interest matters! When borrowing, you would prefer simple interest, but when investing, you would choose compound interest. Why?
Simple interest is calculated on the principal amount. If you are the lender, and you advance R1 000 at 10% per annum, you will earn 10% interest after 12 months, and in the next year, the same amount. By the same token, if you are the borrower, you will pay R100 interest in the first year, and a further R100 interest in the next year.
Described as “interest on interest”, compound interest is calculated on the principal amount plus accumulated interest earned in previous periods. For example, if you make a loan of R1 000 at 10% compound interest per annum, your loan will attract interest of R100 in the first 12 months, and the value of your loan will then be R1 100. In the next year, interest will be calculated on R1 100 and will amount to R110, and your loan value will increase to R1 210, and so on.
Clearly, it is important to understand how interest is dealt with in any loan agreement.
Contact us should you require assistance with any contemplated loan transaction.