Simple vs Compound Interest: What's the Difference?
By SEOAnalytics Lab · Updated · 5 min read
When you save money or borrow it, the interest can be calculated in two ways: simple or compound. The difference looks small at first, but over many years it can change the final amount by thousands of dollars.
This guide explains both types in plain words, shows the formulas, compares them side by side with real numbers and tells you which one works for you when you save and which one works against you when you borrow.
What is simple interest?
Simple interest is calculated only on the original amount, which is called the principal. The interest does not change from year to year, because it never grows on the interest you already earned.
The formula is: Interest = P x r x t, where P is the principal, r is the yearly rate written as a decimal and t is the number of years. The final amount is A = P x (1 + r x t).
What is compound interest?
Compound interest is calculated on the principal and also on the interest that was already added. Each period, the interest joins your balance, and the next interest is calculated on that bigger amount.
The formula is: A = P x (1 + r / n) ^ (n x t), where n is the number of times interest is added each year. With yearly compounding, n is 1.
Side-by-side example: $10,000 at 5%
Say you put $10,000 into an account that pays 5 percent a year, and you leave it alone. Here is what each type gives you.
- After 1 year. Simple: $10,500. Compound: $10,500. There is no difference yet.
- After 5 years. Simple: $12,500. Compound: about $12,762.82.
- After 10 years. Simple: $15,000. Compound: about $16,288.95, which is almost $1,300 more.
- After 20 years. Simple: $20,000. Compound: about $26,532.98.
- After 30 years. Simple: $25,000. Compound: about $43,219.42, which is almost double.
Why the gap grows over time
In the first year both give the same result, because there is no earlier interest to earn on. After that, compound interest earns interest on interest, so each year adds a little more than the year before. Simple interest adds exactly the same amount every year.
This is why time matters so much. For example, $5,000 at 7 percent a year grows to about $19,348 after 20 years and about $38,061 after 30 years with compound interest. The extra 10 years almost double the result.
Simple vs compound interest at a glance
- Calculated on. Simple: the original principal only. Compound: the principal plus the interest already added.
- Growth. Simple: a straight line, the same amount every year. Compound: a curve that grows faster and faster.
- Formula. Simple: A = P x (1 + r x t). Compound: A = P x (1 + r / n) ^ (n x t).
- Best for. Simple: short loans and some bonds. Compound: savings accounts, investments and most credit cards.
Does compounding more often matter?
A little. With $10,000 at 5 percent for 10 years, yearly compounding gives about $16,288.95 and monthly compounding gives about $16,470.09. The gain from adding interest more often is small, so time and regular deposits matter much more than the compounding schedule.
Which one is better for you?
- When you save or invest. Compound interest is better, because your money earns on its own earnings. Start early and add money regularly.
- When you borrow. Simple interest is cheaper for you, because you never pay interest on interest. Compound interest on a debt makes it grow faster.
- Credit cards. Unpaid interest is added to the balance and then earns more interest, so paying only the minimum keeps you in debt for a long time.
How to use a compound interest calculator
- Step 1: Enter your starting deposit. This is the amount you put in on day one.
- Step 2: Add a monthly deposit if you save regularly. Regular deposits make a big difference over the years.
- Step 3: Enter the yearly rate and the number of years. Use the rate your account offers.
- Step 4: Choose how often interest is added. Yearly, quarterly, monthly or daily.
- Step 5: Read the result. See the future value, the interest earned and the year-by-year table.
What the examples do not include
The numbers above assume a fixed rate and no withdrawals. Real savings rates change, investments go up and down, and taxes, fees and inflation are not included. Use them to plan and compare, and speak to a qualified adviser for personal advice.
Try it with your own numbers
Open the Compound Interest Calculator, enter your deposit, rate and years, and see how much of your final balance is interest. It is free, needs no signup and your numbers stay in your browser.
Frequently asked questions
What is the main difference between simple and compound interest?
Simple interest is calculated only on the original amount. Compound interest is calculated on the original amount plus the interest already earned, so it grows faster over time.
How do I calculate simple interest?
Multiply the principal by the yearly rate and by the number of years: I = P x r x t. For $10,000 at 5% for 10 years, the interest is $5,000.
How do I calculate compound interest?
Use A = P x (1 + r / n) ^ (n x t). For $10,000 at 5% for 10 years, compounded yearly, the final amount is about $16,288.95.
Is compound interest always better?
It is better when you save or invest, and worse when you borrow, because the interest on a debt also grows on itself.