The short answer
Simple interest is paid only on the original amount. Compound interest is paid on the original amount and on interest already added — so it grows faster. $10,000 at 5% for 10 years earns $5,000 with simple interest and $6,289 with yearly compounding. Over 30 years the gap becomes $15,000 vs $33,219.
The difference between the two is easy to dismiss after one year — it's zero. After five years it's small. After twenty it's larger than the original deposit. That curve is why compound interest is the engine of long-term saving, and also why long-term debt gets so expensive.
On this page
The two formulas
- Simple interest: I = P × r × t. Principal times rate times time (in years).
- Compound interest: A = P × (1 + r/n)n×t, where n is how many times a year interest is added. Subtract P to get just the interest.
With simple interest, the yearly interest never changes. With compound interest, each year's interest is a little bigger than the last because it's calculated on a bigger balance.
How the gap grows
| Years | Simple interest | Compound (yearly) | Difference |
|---|---|---|---|
| 1 | $500 | $500 | $0 |
| 5 | $2,500 | $2,763 | $263 |
| 10 | $5,000 | $6,289 | $1,289 |
| 20 | $10,000 | $16,533 | $6,533 |
| 30 | $15,000 | $33,219 | $18,219 |
Compounding more often adds a bit more: the same $10,000 at 5% compounded monthly earns $6,470 over 10 years instead of $6,289. Time matters far more than frequency.
Where you'll meet each one
| Usually simple interest | Usually compound interest |
|---|---|
| Many car loans and short personal loans | Savings accounts |
| Bonds paying a fixed coupon | Credit cards |
| Some short-term business loans | Investments with reinvested returns |
| School and exam questions | Mortgages and most long loans (monthly) |
APR vs APY: compounding in the small print
Banks show compounding through two rates. APR is the yearly rate before compounding; APY (or AER in the UK) includes it. A savings account at 5% APR compounded monthly has an APY of about 5.12%.
Making compounding work for you
- Start early. Ten extra years of compounding often matters more than a higher contribution later.
- Reinvest returns rather than taking them out.
- Kill compound debt first. A credit card compounding at 20%+ undoes years of savings growth — see how card interest is calculated.
- Check a quick simple-interest figure with the simple interest calculator, which also shows the compound equivalent.
Frequently asked questions
What's the difference between simple and compound interest?
Simple interest is calculated only on the original amount. Compound interest is also calculated on interest already added, so it grows faster over time.
Which is better, simple or compound interest?
For savings, compound interest earns more. For a loan, simple interest costs less.
What is the simple interest formula?
Interest = principal × rate × time. $5,000 at 5% for 3 years is 5,000 × 0.05 × 3 = $750.
How often is interest compounded?
It depends on the account — daily, monthly, quarterly or yearly. More frequent compounding earns slightly more; the APY or AER shows the combined effect.
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