Simple vs Compound Interest: What's the Difference?
The short answer: simple interest is calculated only on the original principal, so your interest payment stays constant every period. Compound interest is calculated on the principal plus any interest already earned, so your balance grows exponentially over time. For borrowers, compound interest costs more; for savers, it earns more.
| Dimension | Simple Interest | Compound Interest |
|---|---|---|
| Definition | Interest on principal only | Interest on principal plus accumulated interest |
| Formula | I = P × r × t | A = P(1 + r/n)nt |
| Growth pattern | Linear | Exponential |
| Common uses | Short-term loans, auto loans, some bonds | Savings accounts, mortgages, credit cards, investments |
| Borrower impact | Lower total cost for same rate | Higher total cost if balance carried long-term |
What Is Simple Interest?
Simple interest uses the formula I = P × r × t, where P is the principal, r is the annual interest rate, and t is time in years. The interest amount stays the same each period because it is always calculated on the original principal, never on interest that has already been earned.
Simple interest is common in short-term personal loans, some auto loans, and US Treasury bills. A $10,000 loan at 5% simple interest for 3 years costs exactly $1,500 in interest, regardless of when you pay. Use the Simple Interest Calculator to run any scenario instantly.
What Is Compound Interest?
Compound interest reinvests earned interest back into the principal so that subsequent interest is calculated on a growing balance. The formula is A = P(1 + r/n)nt, where n is the number of compounding periods per year. The same $10,000 at 5% compounded monthly for 3 years grows to $11,614 — you pay $1,614 in interest versus $1,500 with simple interest.
That $114 gap seems modest over 3 years, but over 30 years the difference between simple and compound interest is dramatic. $10,000 at 5% simple for 30 years costs $15,000 in interest; compounded monthly it costs $34,885. Use the Compound Interest Calculator to model how quickly compounding accelerates growth (or debt).
Key Differences
The critical factor is time. Over short periods the difference between simple and compound interest is small. Over decades it becomes enormous due to the exponential nature of compounding — often called the "eighth wonder of the world."
- As a saver or investor: compound interest works in your favor. The earlier you start, the more powerful compounding becomes.
- As a borrower: compound interest works against you, especially on revolving debt like credit cards where unpaid interest is added to the balance each month.
- Compounding frequency matters: daily compounding yields more than monthly, which yields more than annual for the same nominal rate.
Which Should You Use (or Look For)?
When saving or investing, always seek accounts that compound frequently — daily or monthly. The Compound Interest Calculator lets you compare how different compounding frequencies affect your final balance. When taking out a loan, ask whether interest is simple or compound. Short-term simple-interest loans can be cheaper. On long-term debt like a mortgage, interest is technically compound (your unpaid interest is capitalized), so pay down principal early to reduce total cost. The Simple Interest Calculator is useful for quick estimates and for evaluating short-term personal or business loans.
FAQ
Is a mortgage simple or compound interest?
Most US mortgages use a simple-interest accrual per day but are structured as amortizing loans, meaning early payments are mostly interest and later ones are mostly principal. Over the full term, the effective behavior resembles compound interest because unpaid interest is folded into the amortization schedule.
How long does it take money to double with compound interest?
Use the Rule of 72: divide 72 by the annual interest rate. At 6% compound interest, your money doubles in roughly 12 years. At 6% simple interest, doubling takes exactly 16.7 years.
Why do credit cards compound interest so aggressively?
Most credit cards compound daily on the outstanding balance. Because the APR is typically high (15–30%) and compounding is daily, carrying a balance even for a few months substantially increases what you owe beyond the stated APR.