What Is Reverse Compound Interest?

Credit cards, mortgages, loans and other debt have interest payments on top of principal, which can accumulate to an unmanageable mountain of debt. Interest is paid either annually, monthly or a term in between. The higher the compounding frequency, the higher your accumulation of interest. Taking steps to reverse compound interest is the first step to debt management.

Meaning

When you pay compound interest, you pay interest on top of principal and interest. If you borrow $100 from a friend and pay him compound interest once at the end of the year at 12 percent, you would owe him $112. If he compounds your interest monthly you would owe him 1 percent each month on $100 which would amount to a few extra cents each month for a total of $112.68 at the end of the year. Reversing compound interest means adding a percentage more to your payments to prevent interest from growing.

Effects

Reversing compound interest has a positive effect on your financial stability. If you can add 10 percent more to your monthly payment, you can reduce and reverse the interest on your debt. The sooner you reduce the extra money on your debt, the interest will be reversed as compounded interest income, rather than compounded interest debt.

Process

As long as you make an additional interest payment to your regular payment, you are in the process of reversing compound interest. To simplify the process of reversing compound interest, you can consolidate your debts into one with lower interest and make one payment with the extra interest payment. Reversing your compound interest with consistent payments is one step closer to living debt free.

Caution

The goal of reversing compound interest is to pay debt off early. Some private lenders may include a prepayment penalty clause in their lending or mortgage agreement to ensure that the lender receives his full interest value. If you sign an agreement with a prepayment penalty clause, you may end up paying an additional percent for paying off your debt early, which makes it harder for your to achieve your debt-free goal. Instead of paying extra on the debt with the penalty, take the extra money and put it toward other debts that don't have a penalty. You'll end up saving on the interest and the penalty.