Simple vs. Compound Interest: What's the Difference?
Same word, same percentage sign, very different math. Whether your money (or debt) compounds can change the total by a lot over enough time.
The core difference
Simple interest is calculated on the original principal only, every time, for the entire term: Principal × Rate × Time. It never grows faster than a straight line. See our Simple Interest Calculator.
Compound interest is calculated on the principal plus any interest already earned, so each period's interest is a little bigger than the last -- growth accelerates instead of staying flat. See our Compound Interest Calculator.
A real example
$10,000 at 5% a year for 20 years, no additional contributions:
| Simple interest | Compound interest (annual) | |
|---|---|---|
| Total after 20 years | $20,000 | $26,532.98 |
| Interest earned | $10,000 | $16,532.98 |
Same starting balance, same rate, same 20 years -- compounding earns about two-thirds more interest, purely from interest earning interest on itself. The gap gets bigger the longer the money sits and the higher the rate, since compounding is exponential and simple interest is linear.
Where each one actually shows up
Compound interest is the default for most savings accounts, credit cards, and investment growth -- it's what makes long-term saving (and long-term credit card debt) grow faster than a flat percentage suggests. Simple interest shows up in some personal loans, car loans, and short-term deposits or bonds, where the lender calculates interest once on the original amount rather than re-compounding it. Simple interest is also the older of the two by a wide margin -- Babylonian clay tablets from around 2000 BC already worked through basic interest problems, long before compounding was formalized as its own concept.
Which is better?
It depends which side you're on. As a saver or investor, you want compound interest -- it's doing more of the work for you over time. As a borrower, you generally want simple interest, since a lender using compound interest on debt you're slow to pay off means you can end up paying interest on interest. Whenever you're not sure which applies to an account or loan, check the terms -- "APR" alone doesn't tell you the compounding frequency, and that frequency is exactly what separates these two.
Frequently asked questions
Does compounding frequency matter, not just simple vs. compound?
Yes, but less than most people expect at typical rates. Daily and monthly compounding end up close to each other over long periods; the difference becomes more noticeable only at higher rates or very long timeframes. The bigger jump is always between simple interest and any form of compounding at all.
Why would anyone choose a loan with simple interest?
As a borrower, simple interest is usually the better deal -- it's easier to predict, and it costs less over time than an equivalent compound rate, since interest never gets charged on interest. It's more common on shorter-term loans, where the gap between the two matters less in absolute dollar terms anyway.
Is credit card interest simple or compound?
Compound, almost always -- and often compounded daily, which is part of why credit card balances can grow uncomfortably fast if they're not paid off. That's the single biggest reason financial advice consistently pushes toward paying credit cards in full each month.
How much does the interest rate itself change the gap between the two?
A lot -- the gap grows with both the rate and the time period, since compounding is an exponential curve and simple interest is a straight line. At a low rate over a short period, the two are close. At a high rate over decades, compounding can end up worth dramatically more than simple interest on the same principal.