Simple vs Compound Interest
What's the difference between simple and compound interest? Side-by-side definitions, formulas, an example, and when each one applies.
Reviewed Jan 15, 2025
Quick answer
Simple interest is calculated only on the original amount. Compound interest is calculated on the original amount plus all interest already earned — so it grows faster over time.
Simple interest in one line
Simple interest = principal × rate × time. The interest earned each period is the same dollar amount because the base never changes.
Compound interest in one line
Compound interest = principal × (1 + rate) ^ time. Each period's interest gets added to the balance, so the next period's interest is calculated on a slightly bigger number.
When you'll see each
- Simple interest: short-term loans, some auto loans, certain bonds, and quick mental-math estimates.
- Compound interest: savings accounts, investments, mortgages, credit cards (compounding works against you here).
$10,000 at 5% for 10 years
A concrete walkthrough you can follow line by line.
Compare $10,000 invested at 5% per year for 10 years under each method.
Simple
10,000 × 0.05 × 10 = $5,000 in interest. Total: $15,000.
Compound (annual)
10,000 × 1.05^10 ≈ $16,289. Compound interest: $6,289.
Difference
$1,289 more from compounding over 10 years.
Result
Compound interest beats simple interest by $1,289 in this scenario.
Frequently asked
- Which is better for savers?
- Compound interest, by a wide margin over long horizons. The longer the money sits, the more compounding pulls ahead.
- Which is better for borrowers?
- Simple interest. With compound interest, unpaid interest gets added to the balance and starts earning interest itself.