Simple vs Compound Interest — What's the Difference?
Simple vs Compound Interest at a Glance
| Simple Interest | Compound Interest | |
|---|---|---|
| Formula | A = P(1 + rt) | A = P(1 + r/n)^(nt) |
| Growth pattern | Linear (straight line) | Exponential (curved) |
| Interest earned on | Original principal only | Principal + accumulated interest |
| Best for | Borrowers (lower cost) | Savers/investors (higher returns) |
Side-by-Side Comparison: $10,000 at 7%
| Year | Simple Interest | Compound Interest (Monthly) | Difference |
|---|---|---|---|
| 1 | $10,700 | $10,723 | $23 |
| 5 | $13,500 | $14,176 | $676 |
| 10 | $17,000 | $20,097 | $3,097 |
| 20 | $24,000 | $40,387 | $16,387 |
| 30 | $31,000 | $81,165 | $50,165 |
After 30 years, compound interest earns $50,165 more than simple interest on the same $10,000 investment. That’s the exponential advantage.
How Simple Interest Works
Simple interest is calculated once on the original principal:
Interest = P × r × t
- $10,000 at 7% for 1 year = $10,000 × 0.07 × 1 = $700/year, every year
- The interest never changes because it’s always based on the original $10,000
Where simple interest is used:
- Auto loans
- Some personal loans
- Treasury bills
- Short-term certificates
How Compound Interest Works
Compound interest calculates interest on the growing balance:
Year 1: $10,000 × 7% = $700 → Balance: $10,700 Year 2: $10,700 × 7% = $749 → Balance: $11,449 Year 3: $11,449 × 7% = $801 → Balance: $12,250
Each year earns more than the last because the base amount keeps growing. This is the “snowball effect” of compounding.
Where compound interest is used:
- Savings accounts
- Certificates of deposit (CDs)
- Investment accounts
- Credit card balances
- Mortgages
The Long-Term Impact
The gap between simple and compound interest widens dramatically over time:
- 10 years: Compound earns 18% more
- 20 years: Compound earns 68% more
- 30 years: Compound earns 162% more
- 40 years: Compound earns 338% more
This is why starting to invest early matters so much — you’re giving compound interest more time to create that exponential curve.
→ Compare scenarios in our calculator
Key Takeaway
When you’re saving or investing, seek compound interest — it works for you exponentially. When you’re borrowing, prefer simple interest — it costs you less over time.
Related Tools
- Compound Interest Calculator — See your money grow with compounding
- Compound Interest Formula — The math explained
- Rule of 72 — Quick doubling time estimate
Frequently Asked Questions
What's the main difference between simple and compound interest? ▾
Simple interest is calculated only on the original principal, so growth is linear. Compound interest is calculated on the principal plus previously earned interest, creating exponential growth. Over time, compound interest earns significantly more.
Which is better, simple or compound interest? ▾
For savings and investments, compound interest is better because you earn interest on your interest. For loans, simple interest is better for the borrower because you pay less total interest.
Do banks use simple or compound interest? ▾
Most savings accounts, CDs, and money market accounts use compound interest (usually daily or monthly). Most auto loans and some personal loans use simple interest. Credit cards use compound interest on unpaid balances.