Compound Interest Calculator: Should I choose a rolled-up interest or serviced for my bridging loan?

Compound Interest Calculators are financial tools designed to calculate the growth of an investment or the accumulation of debt over time, factoring in compound interest. They are useful for borrowers considering bridging loans and weighing the options between rolled-up interest or monthly repayments.

Compound Interest Calculator

Understanding compound interest is key when deciding the interest options for your bridging loan. Rolled-up interest allows you to defer payments until the end of the loan term, which can help if your exit strategy relies on a large payout later on. However, due to compounding, it will increase your overall costs. On the other hand, serviced interest requires regular monthly payments covering interest, reducing your total interest cost over the loan term. But what interest option should you choose for your bridging loan?

This article covers compound interest, how it can be calculated, and helps you understand whether this type of interest is right in your situatuon. 


What is Compound Interest?

Compound interest is the interest calculated on the initial principal and the accumulated interest of previous periods, leading to the exponential growth of the debt or investment over time.

What does compound interest mean for borrowers?

For borrowers, compound interest means that the amount of interest owed increases over time because interest is calculated on both the initial principal and the accumulated interest from previous periods. This leads to the loan balance growing more quickly compared to simple interest, resulting in higher overall repayment amounts if the interest is not paid off regularly.

What does compound interest mean for lenders?

For lenders, compound interest means that the amount of interest earned increases over time because interest is calculated on both the initial principal and the accumulated interest from previous periods. This results in higher returns on loans and investments compared to simple interest, as the interest compounds and grows more quickly.

What does compound interest mean for savers?

For savers, compound interest means that the amount of interest earned increases over time because interest is calculated on both the initial principal and the accumulated interest from previous periods. This results in savings growing more quickly compared to simple interest, leading to greater returns on investments as the interest compounds and generates more interest over time.

How does Compound Interest work?

Compound interest is calculated by applying the interest rate to both the initial principal and the interest that has been added to it over time.

Compound interest is like a domino effect: it grows your debt faster the longer the loan stays borrowed, or conversely, in the case of savers and lenders, it increases the amount owed to you.

Compound Interest examples

In various circumstances, compound interest is used, from bank accounts to investments to mortgages.

Let's consider a scenario where you deposit £1,000 into a savings account with an annual interest rate of 3%, compounded annually. Here's how your savings would grow over time:

  • After the first year:
    • Interest earned = £1,000 x 3% = £30
    • Total balance = £1,000 + £30 = £1,030
  • After the second year:
    • Interest earned = £1,030 x 3% = £30.90 (rounded to two decimal places)
    • Total balance = £1,030 + £30.90 = £1,060.90
  • After the third year: 
    • Interest earned = £1,060.90 × 3% = £31.83 (rounded to two decimal places) 
    • Total balance = £1,060.90 + £31.83 = £1,092.73

This process continues, with your money steadily accumulating interest on both the initial deposit and the interest already earned. Over time, the impact of compound interest becomes more pronounced, helping your savings grow faster than with simple interest alone.

Why is Compound Interest so powerful?

Unlike simple interest, which only calculates earnings on the initial amount, compound interest includes the interest you've already earned, compounding your returns. This compounding effect makes it attractive for anyone looking to build wealth steadily. But what are the three key benefits of compound interest?

  1. Accelerated Growth: Your money grows exponentially as interest builds on itself.
  2. Long-Term Wealth: Perfect for building a solid financial foundation through consistent saving and investing.
  3. Passive Income Potential: Reinvesting earnings allows your investments to grow even when not actively adding funds.

What is the formula for Compound Interest?

Compound Interest Formula

How to work out Compound Interest

Working out compound interest is more complicated than simple interest. Here’s a four-step guide on how to work out how much impact you’re earning or how much you have to pay. 

  1. Obtain the information. Collect principal amount, annual interest rate (as a decimal), time period (in years), and compounding frequency.
  2. Use formula. Use the compound interest formula: A=P(1+r/n)nt
  3. Plug in values. Substitute gathered values into the formula.
    • A is the future value of the investment or loan (including interest)
    • P is the principal amount (initial investment or loan)
    • r is the annual interest rate (as a decimal)
    • n is the number of times interest is compounded per year
    • t is the time the money is invested (in years)
  4. Interpret result. ‘A’ represents the total amount, including the initial investment or loan and the accumulated interest.

Compound Interest vs Simple Interest

The key difference between compound and simple interest lies in how interest is calculated and applied to the initial amount.

But what are the other differences between compound interest and simple interest?

Aspect Compound Interest  Simple Interest
Growth over time Exponential growth, accelerating over time Linear growth, constant over time
Return amount Higher Lesser
Calculation Interest earned on both principal and accumulated interest Interest earned only on the principal amount
Formula A=P(1+r/n)nt A=P×r×t

Simple Interest examples

If you deposit £1,000 into a savings account with a simple % interest rate of 3% per year. After 3 years, how much interest would you earn?

Using the formula for simple interest:

Simple Interest Formula

Interest = £1,000 × 0.03 × 3 = £90

So, over 3 years, you would earn £90 in interest on your £1,000 deposit in the savings account.

Simple vs Compound Interest example

If we were to compare a simple and compound interest over a 15-year period with an initial deposit of £5,000 and an interest rate of 4%.

Simple Interest:

Interest = P×r×t

Interest = £5,000 × 0.04 × 15 = £3,000

With simple interest, the total interest earned over 15 years would be £3,000. The total balance after 15 years would be the initial deposit (£5,000) plus the interest earned (£3,000), resulting in a total balance of £8,000.

Compound Interest:

Interest: A=P(1+r/n)nt

A = £5,000 × (1+0.04/1)1x15

A = £5,000 × (1.04)15

A = £8,446.80

With compound interest, the total balance after 15 years would be £8,446.80.

The difference between compound interest and simple interest over the 15-year period would be the final balance with compound interest (£8,446.80) minus the final balance with simple interest (£8,000), resulting in approximately £446.80 more with compound interest.

Compound interest typically earns significantly more than simple interest over long periods, often resulting in substantial gains in wealth accumulation or interest payments.


What is Compound Interest on a loan?

Compound interest on a loan isn't just about paying interest on the initial amount you borrowed. It's about paying interest on top of interest, which can quickly add up.

For example, if you borrow £150,000 at a 10% interest rate compounded yearly. After 10 years, you'd owe around £386,968.77. This includes both the interest that's been accumulating and the original loan amount. 

As time passes, the interest grows, making your total repayment amount much higher than what you initially borrowed. Understanding compound interest is crucial for borrowers to grasp the full picture of their loan costs and make informed financial decisions

Compound Interest on debt

Compound interest on debt can significantly impact the total amount owed, particularly for long-term debts or high-interest loans. As interest continues to compound, the total repayment amount can escalate, making it challenging for borrowers to pay off their debts and potentially leading to a cycle of debt accumulation.


What is a Compound Interest Calculator?

A Compound Interest Calculator is a financial tool used to estimate the growth of an investment or the accumulation of debt over time, taking into account the effects of compound interest. It allows users to input variables such as the initial principal amount, interest rate, compounding frequency, and period to calculate the future value of an investment or the total amount owed on a loan or debt.

You should also be aware of the following 5 key terms. 

  1. Annual Percentage Rate (APR). APR represents the annualised interest rate charged on a loan or credit card, including fees and other costs associated with borrowing. It gives borrowers a standardised measure to compare borrowing costs across different financial products.
  2. Monthly Percentage Rate (MPR). Most loans, such as credit card loans or mortgages, are calculated as the annual percentage rate (APR) of the charge. It is the interest rate for the whole year rather than a monthly rate. However, while calculating the interest rate for monthly dues, such as the interest on bridging loans, the monthly percentage rate (MPR) will be applied to the transactions.
  3. Daily Periodic Rate (DPR). Depending on the loan issuer, the daily periodic interest rate can be calculated by dividing the annual percentage rate (APR) by 365 (the number of days in a year). While compounding interest daily is unusual, it is an option for lenders when offering short-term bridging loans.
  4. Annual Equivalent Rate (AER). AER is a measure used to calculate and compare the interest earned on savings accounts or investments over one year, considering compound interest. It reflects the actual annual interest rate earned, considering the compounding frequency.
  5. Annual Percentage Yield (APY). APY is similar to AER but is commonly used in investments to represent the annual rate of return earned on an investment, including both interest and the effect of compounding. It gives investors a standardised measure to compare the returns on different investment options.

How to use a Compound Interest calculator?

A compound interest calculator helps predict how investments or savings grow over time by factoring in initial principal, interest rate, compounding frequency, and duration. It demonstrates the compounding effect, where interest earned on both the principal and accumulated interest aids in financial planning for goals like retirement savings or investment strategies.

  1. Rolled Up
    £0 per month
    Amount repayable at end of term:
    £0.00
    Total Interest: £0.00

    Serviced
    £0.00 per month
    Amount repayable at end of term:
    £0.00
    Total Interest: £0.00


What is a bridging loan?

A bridging loan, also known as "bridge finance" or "bridge loan," is short-term financing used to bridge financial gaps. Bridging loans are commonly used for property transactions, with 38% of borrowers using them to purchase their primary residence and 31% for investment properties or property development. These loans are typically secured against properties but can use other assets like land as collateral.

Bridging finance has three interest types: rolled-up, retained, or serviced interest. Each affects how interest accrues over the loan term. Rolled-up interest, for instance, compounds over time, potentially increasing total costs compared to other options.

How does the interest type affect bridging loans?

The interest on a bridging loan significantly impacts its structure and repayment. There are three key interest types.

  1. Rolled-Up Interest: Rolled-up interest involves accumulating interest throughout the loan term without making regular monthly payments. Instead, the entire interest amount and the principal are repaid in full at the end of the loan period, usually when the property is sold or refinanced. This option allows borrowers to defer interest payments, easing short-term cash flow but increasing the total interest cost over the loan duration.
  2. Retained Interest: With retained interest, borrowers pay part of the interest each month from their own funds while the remainder accrues and is paid in a lump sum at the loan's maturity. This option reduces the overall interest burden compared to rolled-up interest because partial interest payments prevent the total interest from compounding fully over time.
  3. Serviced Interest. Serviced interest requires borrowers to make regular monthly payments covering interest and possibly some principal repayment. This option ensures that interest obligations are met throughout the loan term, offering greater predictability in budgeting and reducing the total interest paid compared to rolled-up interest.

Use our free bridging loan calculator to determine how much a bridging loan might cost you. 

What's the better interest option: rolled up, retained or serviced?

It all comes down to your circumstances when deciding between rolled-up, retained, or serviced interest for a bridging loan.

Rolled-up Interest is ideal for borrowers facing short-term cash flow constraints anticipating a substantial influx of funds later, such as from a property sale. It provides immediate relief from monthly interest payments, though it typically results in higher overall interest costs due to compounding.

Retained Interest suits borrowers seeking a balance between managing cash flow and reducing total interest expenses compared to rolled-up options. It allows partial monthly interest payments, offering flexibility while deferring some costs to the loan's maturity.

Serviced Interest is best for borrowers with consistent incomes who prioritise predictability in monthly payments and aim to minimise total interest paid over the loan term. It ensures regular payments cover both interest and possibly some principal, requiring consistent income to meet obligations.

Consider whether immediate relief or long-term cost management is more critical, evaluate your financial stability to meet monthly payments, and compare total interest costs against your financial goals. 


What are interest rates?

Interest represents the cost of borrowing money or the earnings you receive for depositing money in a bank. It's the fee lenders charge borrowers and the reward banks provide to savers for keeping funds in their accounts.

How does Compound Interest get affected when rates change?

Changes in bank rates directly impact compound interest. When bank rates increase, the interest rate applied to savings or loans also rises. For savings, higher rates lead to accelerated growth of compounded interest over time. Borrowers face increased costs due to higher interest rates, resulting in more significant interest owed over the loan term.

What does it affect when interest rates change?

Interest rates impact savings and bridging loans. If interest rates were to increase, what would the impact be on the following?

Savings

When interest rates change, they directly impact savings accounts. Higher interest rates mean that savers earn more on their deposits over time, encouraging people to save more as their savings grow faster. 

Mortgages

Changes in interest rates significantly affect mortgage rates. Mortgage rates tend to move with the changes in the Bank of England (BoE) rate. When interest rates rise, mortgage rates also increase, making it more expensive for borrowers to finance home purchases or refinance existing loans. 

Pensions

Interest rates impact pensions, especially for defined-benefit pension schemes. These schemes often use interest rates to calculate future liabilities and funding requirements. Lower interest rates increase pension scheme liabilities because they reduce the expected investment returns on pension fund assets. This can lead to higher funding deficits and increased pressure on employers to make up shortfalls. 

Bridging loans

Bridging loans are typically sensitive to changes in interest rates because they are taken out for relatively short periods. Changes in interest rates can impact the cost of servicing these loans for borrowers. Higher interest rates increase the cost of borrowing through bridging loans, potentially affecting affordability and financial planning

How does the BoE rate differ from interest rates?

The BoE rate, also known as the base rate, is the interest rate at which the BoE lends money to commercial banks. It’s a benchmark for other interest rates but does not directly determine rates for individual loans or savings accounts.


Final thoughts

The Compound Interest Calculator helps borrowers evaluate bridging loans, comparing rolled-up and serviced interest options. Compound interest accumulates on both principal and prior interest, significantly affecting total loan costs.

Rolled-up interest defers payments to the loan's end, aiding short-term cash flow but increasing overall costs due to compounding. In contrast, serviced interest requires regular payments, reducing total interest by preventing full compounding. At the end of the day, it's up to you to decide what type of interest best suits your circumstances. 

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