Finance
Simple vs Compound Interest
Both are ways interest is calculated, but the difference compounds — literally. Over long periods, compound interest pulls dramatically ahead of simple.
| Aspect | Simple interest | Compound interest |
|---|---|---|
| Charged on | The original principal only | Principal plus interest already earned |
| Growth pattern | Straight line (constant each period) | Accelerating curve |
| Formula | P × r × t | P × (1 + r)^t |
| Over long periods | Falls behind | Pulls far ahead |
| Where you see it | Some short-term loans, certain bonds | Savings, mortgages, credit cards, investments |
When to use simple interest
Simple interest is easiest to reason about and applies to some short-term borrowing — useful for a quick, exact figure.
When to use compound interest
Compound interest is what governs most saving, borrowing, and investing, so it’s the one to understand for real financial decisions.
Frequently asked questions
- Which grows money faster?
- Compound interest, because each period’s interest joins the balance and starts earning too. The longer the time horizon, the larger the gap over simple interest on the same amount.
- Is compound interest always better?
- It’s better when you’re earning it and worse when you’re paying it. Compounding works powerfully in your favor on savings and against you on credit-card debt.
- How much difference does it make?
- $5,000 at 5% for 10 years earns $2,500 in simple interest but about $3,144 compounded yearly — and the gap widens sharply over longer periods.