Simple vs. Compound Interest Explained

The difference between interest on principal alone and interest that builds on itself, with examples.

Interest can work for you or against you, and the way it is calculated makes a big difference. The two basic types are simple interest and compound interest. Knowing which applies helps you evaluate savings accounts, investments and loans.

Simple interest

Simple interest is calculated only on the original principal. The formula is principal × rate × time. If you deposit $10,000 at 5% simple interest for 10 years, you earn $500 a year, or $5,000 in total, and end with $15,000.

Compound interest

Compound interest is calculated on the principal plus interest already earned. Each period's interest is added to the balance, so the next period's interest is larger. With $10,000 at 5% compounded annually for 10 years, the balance grows to $16,288.95, which is $1,288.95 more than simple interest gives.

How compounding frequency matters

Interest can compound annually, monthly or daily. More frequent compounding produces slightly more growth at the same stated rate. For $10,000 at 5% for 10 years, annual compounding gives $16,288.95, while monthly compounding gives $16,470.09.

The effect of time

Compounding becomes more powerful the longer money is left alone. Over 30 years, $10,000 at 5% compounded annually grows to $43,219.42, compared with $25,000 under simple interest. Starting early often matters more than the exact rate.

Compound interest on debt

Compounding works against borrowers on revolving debt such as credit cards, where unpaid interest is added to the balance. Most installment loans, such as auto and mortgage loans, use a simple-interest approach on the declining balance, with each payment covering interest first and then principal.

Savings versus loans

• Savings and investments: compounding helps your money grow.
• Credit cards: compounding raises the cost of carrying a balance.
• Installment loans: interest is charged on the remaining balance and the schedule is fixed.

APR and APY

APR states a yearly rate without compounding, while APY includes the effect of compounding. When comparing savings accounts, APY is the better number. When comparing loans, APR is the standard disclosure.

The rule of 72

A quick estimate of how long money takes to double is 72 divided by the annual rate. At 6%, doubling takes about 12 years. It is an approximation, not a guarantee.

Limits and caution

Real returns on investments are not guaranteed and can be negative. Account fees, taxes and inflation also reduce the real value of growth. Treat projections as illustrations, not promises.

Try it yourself

Use the interest calculator to project growth from a starting amount, and compare it with the loan calculator to see how interest works on a borrowed balance.

Common misunderstandings

• A higher stated rate is not always better if fees or compounding differ.
• Compounding helps savings but also raises the cost of unpaid debt.
• Early deposits benefit more than late deposits at the same rate.

Adding regular contributions

Regular deposits make compounding more powerful, because each new contribution also starts earning interest. Even small monthly additions can grow into a meaningful sum over decades. Check whether an account has fees or minimums that reduce your returns, and remember that projections are estimates rather than guarantees.

Choosing between accounts

When comparing savings products, check the APY, minimum balance, fees and whether the rate is fixed or variable. A slightly lower rate with no fees can beat a higher rate with charges that eat into your balance, so read the account terms carefully before you deposit money.

Bottom line

Compounding rewards patience on savings and punishes unpaid debt, so let it work for you wherever you can.

Important

This guide is educational and not individualized financial advice. Loan terms vary by borrower, lender and market, so confirm details in the official disclosure.