Compound Interest is where interest charged on a loan is described as:

• A. Is deducted from the original loan amount on an annual basis.
• B. Only relates to repayments on outstanding arrears.
• C. Is added to the loan amount and from then on the new loan amount equals the original capital and the interest charge.
• D. Only relates to the additional interest charged to a borrower on the capital borrowed if they are in arrears.

Answer: (C)

Compound interest means interest is earned on both the original amount borrowed and on any interest that has already accrued. Each period, the interest is added to the outstanding balance, so the next period’s interest is calculated on this larger amount. The statement describes this exactly: the interest is added to the loan amount, creating a new balance that equals the original capital plus the accumulated interest. That is the essence of compound interest.

The other descriptions relate to withholding or applying interest in ways that don’t reflect the growth of the balance due to accumulated interest (for example, reducing the principal or charging extra only when there are arrears).