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]]>Therefore, individuals who are planning to make investments should understand certain factors about this interest calculation method to maximize their benefits.
Here are some of the notable factors to consider while using this method of interest calculation –
The concept of compound interest has a straightforward yet accurate explanation which is interest upon interest. The appropriate clarification of this is that the earnings from the investment are added to compile further income. However, this particular concept is not applicable for simple interest as it evaluates return from the principal amount and does not consider previously produced interest income.
Therefore this evaluation process ensures substantial growth over a similar period compared to a simple interest mechanism. However, one must note that this calculation process is not applicable to borrowing options like personal loans and others.
One of the crucial factors to consider when evaluating profits from the compounding method is the investment perspective. Usually, compound interest has better prospects in generating considerable returns over a long period. The primary reason behind this is that the subsequent interest is cumulated on the actual investment and compounded periodically to generate substantial income. This is why most financial institutions suggest investors choose a longer investment plan.
While comprehending how compounding assists in producing higher income, one must note that these earnings can increase many times with a higher frequency. Typically, this frequency can be quarterly, yearly, half-yearly for compound interest. Following is an example to understand it better.
For instance, an income of Rs.6.5 lakh will bring about returns of approximately Rs.10.35 lakh when compounded yearly at an interest rate of 10% for 10 years. On the other hand, if the same amount is compounded every 6 months, it will generate a total interest worth Rs.10.74 lakh.
As already stated, one of the crucial factors that decide the portion of returns while evaluating interest is time. Therefore, it is smart to prioritize investment in the early years, as the investment amount will be compounded for a longer period, and a considerable income will be generated during their retirement.
While being prudent on the method of increasing income from the investments, one should also factor in the compound interest rate. It is one of the primary aspects that determines the overall returns against an investment product. If the rate is higher, profit will increase proportionately. This factor is true for evaluating simple interests as well.
Although a higher interest rate is preferable for investment units, however, a lower rate is desirable for credit instruments such as a personal loan. Besides, one should also learn that the compound interest rate formula does not apply to every credit instrument.
Instead, personal loans and other financial products follow the reducing balance method to ensure affordable repayment. In this regard, individuals must note the factors affecting personal loan interest rates and plan accordingly to obtain the best deal.
Although compounding is profitable for the investors, it can be a trouble in terms of borrowing. On the contrary, the reducing balance method, which is applicable for personal credit, is a better option. Considering this method, lenders assess the payable interest amount depending on the outstanding balance.
Therefore, with the following mathematical formula, it is represented like this:
Therefore, just like the EMI reduces with every payment, so does the interest amount.
For example, a borrower availed a loan amount of Rs.6 lakh at a reducing interest rate of 12% for a tenor of four years. Therefore, the overall outstanding interest component will be Rs. 1,58,424. After the borrower pays his/her first EMI of around Rs. 15,800, the interest amount in the next month will be evaluated based on the initial outstanding amount, subtracting the paid amount. In this regard, borrowers can significantly reduce their outstanding sum by planning their personal loan EMI repayment better.
Similarly, borrowers need to consider multiple other reasons to comprehend how they can get a better interest rate on a personal loan or any other credit instrument. This can involve meeting eligibility requirements, improving credit scores, maintaining the credit utilization ratio, and more.
Besides lowering interest rates on loans, borrowers can choose lenders who simplify loan application procedures. For instance, Bajaj Finserv extends pre-approved offers that expedite the loan application process. These offers are available on a wide range of financing options such as personal loans, business loans, credit cards, etc. Therefore, one can check their pre-approved offer by mentioning their credentials.
To sum it up, if you are looking for a healthy investment plan instead of borrowing credits to meet your financial requirements, consider the aforementioned pointers on compound interest while making a decision.
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