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 an example to show you how it works.

Your compound interest rate takes into account the interest you pay on interest as well as the outstanding amount if you don’t pay your balance off every month. Even if you do pay your balance off every month, the compound rate shows how much interest you’d pay each year if you didn’t.

Compound rates will also go up or down when the Bank of England Base Rate changes but the changes will be bigger than the changes to the simple interest rates because they take in to account the interest on interest.

Where to find your interest rates

How to compare interest rates

Comparing to purchase and cash interest rates

Most credit card issuers just show compound interest rates. This means that you can use the standard and cash compound rates on your Barclaycard to compare against the purchase and cash interest rates on most other credit cards.

Comparing to APR (Annual Percentage Rate)

You can also use your compound standard rate to compare against the APR of another card, unless the other card has annual or monthly fees.

An APR is a rate that is used to give people a standard way of comparing the costs of different credit cards, before they apply. In advertising, lenders use a rate called the representative APR. This is the APR you are most likely to get if you are successful because some card issuers give different APRs to different customers.

The APR is based on the interest rate charged on purchases and will usually be the same as the compound purchase rate. But this is not always the case because the APR also takes into account any monthly or annual fees you pay for having the card.

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 a business borrowing £1,000 at a simple interest rate of 12%. For the sake of the example, let’s say that the business 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 your balance each month?

The business borrowed the money in December, so interest is charged for the first time in January. Their yearly simple standard rate is 12%, so their monthly simple rate is 1% (the simple standard rate divided by 12). Because the business doesn’t pay, their £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 the businesses 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.

A business borrows the £1,000 in December, so interest is charged for the first time in January

January – interest is 1% of £1,000, which is £10

February – interest is 1% of £1,010, which is £10.10

March – interest is 1% of £1,020.10, which is £10.20

By December, the business needs to pay £1,126.83 to clear their balance

After 12 months, the interest has increased the amount the business owes by £126.83. If the business had been charged only a simple interest rate, the business would have been charged £120 over 12 months. However, because interest is charged on interest (compound interest), the business would be charged an extra £6.83 over 12 months. So the total amount that the business would be charged is £126.83.

View a full yearly example showing how interest is charged month on month

The example shows that over 12 months, the business is charged £126.83 in interest on the £1,000 that the business 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 ‘How To Improve Your Credit Score’ guide to learn more.

With Barclaycard Payments, you must pay the minimum amount each month

Remember that this is just an example to show how compound interest works. With a Barclaycard business credit card, 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. Please refer to ‘How Is Credit Card Interest Charged‘, in your T&Cs’ to find out more.

Getting to know simple and compound interest