Compound interest occurs when interest gets added to the original amount borrowed, and then the interest rate applies to the new number.
Example:
Say you borrow $1,000 with a 2% interest rate that compounds monthly.
In the first month, you would owe interest on the $1,000 principle, which comes to $20
In the second month, you would owe 2% on that original amount plus $20 interest, which comes to $20.40
At the end of the first year, you will owe $1268.24—the initial $1,000 plus $268.24 in interest.
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