Recently we discussed that not all loans are created equal because of the way the lender structures your payments. But loans can also differ in the way they charge interest. And this is bigger than loans–this is also a major key in how you earn interest.

The big difference is whether the loan/investment uses Simple or Compound interest.

Simple Interest Examples:
– Savings Bonds
$100 invested at 4% for 10 years.
$100 x .04 x 10 = $40 interest earned.

– Line of Credit
$100 borrowed at 5% for 5 years.
$100 x .05 x 5 = $25 interest owed.

With Simple Interest, the interest builds in a straight line.

Compound Interest Examples:
– Stock Market
$100 invested at 4% for 10 years.
$100 x (1 + .04)¹⁰ – $100 = $48 interest earned

-Home Mortgage
$100 borrowed at 5% for 5 years.
$100 x (1 + .05)⁵ – $100 = $27 interest owed.

With Compound Interest, the interest builds in a curved line.

We used small examples to keep the math easy, but let’s run it again with some larger examples:

Savings Bond: $10,000 invested at 4% for 30 years
$10,000 x .04 x 30 = $12,000 interest earned.

Line of Credit: $100,000 borrowed at 5% for 30 years
$100,000 x .05 x 30 = $150,000 interest owed.

Stock Market: $10,000 invested at 4% for 30 years
$10,000 x (1 + .04)³⁰ – $10,000 = $22,433 interest earned.

Home Mortgage: $100,000 borrowed at 5% for 30 years
$100,000 x (1 + .05)³⁰ – $100,000 = $332,194 interest owed.

The act of compounding has the power to double the amount of interest generated by a loan/investment over the course of 30 years.