What It Means
Compound interest is interest calculated on the initial principal plus all previously accumulated interest - essentially 'interest on interest.' This compounding effect makes both savings and debts grow exponentially over time. Credit cards use daily compounding, meaning interest accrues on your balance plus any previously accumulated interest every single day. For savings and investments, compound interest works in your favor, growing your wealth over time. For debts, it works against you, making balances grow faster than simple interest would. Einstein reportedly called compound interest 'the eighth wonder of the world,' noting that those who understand it earn it, while those who don't pay it. This concept is fundamental to understanding why credit card debt grows so quickly and why early investing is so powerful.
Frequently Asked Questions
How does compound interest affect credit card debt?
Credit cards compound interest daily. If you carry a $5,000 balance at 22% APR, you accrue roughly $3 per day in interest - and that interest gets added to your balance, generating even more interest the next day.
Is compound interest always bad?
No. When saving or investing, compound interest is extremely powerful and beneficial. The key is to be on the earning side (investments) rather than the paying side (debts).