What Is Simple & Compound Interest?
Getting to know simple and compound interest
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.
Amy’s story – an example to show how compound interest 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.
What happens to Amy’s balance each month?
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.
Amy borrows the £1,000 in December, so interest is charged for the first time in January
showing how interest is charged month on month
The example shows that over 12 months, Amy is charged £126.83 in interest on the £1,000 that she borrowed at a simple interest rate of 12% per year. This means that the compound interest rate was 12.7% per year (£126.83/£1,000)
What compound interest means for you
With compound interest, interest is charged on interest from the previous month. So the longer it takes to clear your balance, the more you’ll pay in compound interest. It’s important that you try to clear your balance as quickly as you can. If you have problems with your credit score, this becomes even more important. Read our guide How To Improve Your Credit Score to learn more.
With Barclaycard, you must pay the minimum amount each month
Remember that Amy’s story is just an example to show how compound interest works. With a Barclaycard, you must pay at least the minimum amount each month. If you don’t pay your monthly payment on time, you may be charged a fee. Also, your credit rating could be affected, making it harder for you to get credit in future. You can use our guide, How Is Credit Card Interest Charged to find out more.