What does compound interest encompass?

Compound interest is a financial concept that refers to the way interest is calculated on a principal sum of money, where interest earned over time is added back to the principal. This means that in subsequent interest calculations, the interest is computed not just on the original principal, but also on any interest that has already been accrued. As a result, compound interest has the potential to grow the investment or debt more significantly than simple interest, which is calculated only on the original principal amount.

In this context, the correct choice highlights that compound interest includes interest calculated on both the principal and any accumulated past interest. This characteristic of compounding allows for exponential growth over time, making it a crucial concept in finance and lending practices. Understanding how compound interest works is essential for loan signers and real estate professionals, as it affects loan repayment amounts and investment growth.

While the other options mention aspects related to loans, they do not accurately represent the definition or scope of compound interest. The principal alone, taxes, or payments made do not encompass the compounding nature of interest that adds previously earned interest to the base amount for future calculations.