To understand how interest affects your outstanding balance and payments, it’s important to get to know simple and compound interest. We’ve created Amy’s story to show you how it works.
To show you how compound interest affects a balance over time, we’re going to use a made-up example based on Amy borrowing £1,000 at a simple interest rate of 12%. For the sake of the example, let’s say that Amy doesn’t pay anything back for 12 months. Note that this example is just to show how compound interest works – it is not related to any specific financial product or service.
Amy borrowed the money in December, so interest is charged for the first time in January. Her yearly simple standard rate is 12%, so her monthly simple rate is 1% (the simple standard rate divided by 12). Because Amy doesn’t pay, her £1,000 balance (plus 1% interest) is rolled over to February when interest is charged again. This time interest is charged not only on the original balance but also on the interest from January – we call this compound interest.
This example shows how interest affects Amy’s balance over 12 months. We’ve rounded the figures to the nearest 1p. You’ll see how the longer you take to pay off your balance, the more it will cost.