What is "compounding interest" and why is it dangerous?

Compounding interest means you pay interest on your interest. It turns a small debt into a large one very quickly.

Simple Interest vs. Compound Interest

Simple interest: You only pay interest on the original amount you borrowed.

Example: Borrow ₦100,000 at 10% simple interest per year. Each year, you pay ₦10,000 in interest. After 3 years, you have paid ₦30,000 total.

Compound interest: You pay interest on the original amount AND on any unpaid interest that has accumulated.

Example: Borrow ₦100,000 at 10% compound interest per year.

• Year 1: ₦100,000 × 10% = ₦10,000 interest → owe ₦110,000
• Year 2: ₦110,000 × 10% = ₦11,000 interest → owe ₦121,000
• Year 3: ₦121,000 × 10% = ₦12,100 interest → owe ₦133,100

After 3 years, you owe ₦133,100 instead of ₦130,000. The difference seems small. But over longer periods, it becomes enormous.

The Rule of 72 (A Quick Way to See the Danger)

The Rule of 72 tells you how many years it takes for your debt to double at a given interest rate.

Years to double = 72 ÷ Interest Rate

Examples:

• At 36% interest (Canada's cap): Your debt doubles every 2 years (72 ÷ 36 = 2)
• At 72% interest: Your debt doubles every 1 year
• At 100% interest: Your debt doubles every 8.6 months

This is how a small loan becomes an unpayable monster.

Why Predatory Loan Apps Love Compound Interest

Most predatory loan apps use compound interest calculated daily. A 1% daily compound interest rate becomes:

• After 30 days: Debt = Original × 1.01^30 = Original × 1.35 (35% increase)
• After 60 days: Debt = Original × 1.01^60 = Original × 1.82 (82% increase)
• After 90 days: Debt = Original × 1.01^90 = Original × 2.45 (145% increase)

Your debt more than doubles in 3 months.

Step-by-Step Action

Step 1: Read the loan terms carefully. Look for words like "daily interest," "compounding," or "interest on interest."

Step 2: Ask the lender: "Is interest simple or compound? How often is it calculated?"

Step 3: If the loan uses compound interest, pay it off as quickly as possible. Do not let it sit.

Step 4: Avoid any loan with daily compound interest. It is designed to trap you.