What is the compounded interest rate mentioned?

In the context of compounded interest rates, the term refers to the percentage at which interest on a loan or investment accrues over time. Compounded annually means that the interest is calculated and added to the principal once each year. Understanding the concept of compounding is critical, as it affects the overall financial outcome.

In this scenario, a compounded interest rate of 5% indicates that each year, the principal amount will increase by 5%. For example, if you start with a principal of $1,000, after the first year, you would earn $50 in interest, bringing the total to $1,050. In the second year, interest will be calculated on the new principal of $1,050, resulting in a higher interest amount than in the first year due to the compounding effect. This process continues each year, leading to exponential growth of the principal.

Thus, a compounded interest rate is crucial for determining the future value of an investment or the total cost of a loan over time. The 5% rate provides a balance between a reasonable return or cost without being excessively high, which is important in various financial contexts.