Simple Interest vs Compound Interest: The Difference
Simple interest is charged only on the principal; compound interest is charged on the principal plus accumulated interest. The difference compounds dramatically over time.
| Aspect | Simple Interest | Compound Interest |
|---|---|---|
| Charged on | Principal only | Principal + accumulated interest |
| Formula | P × r × t | P × (1 + r)^t − P |
| Growth | Linear | Exponential |
| Over long periods | Lower total | Much higher total |
| Common uses | Some short loans | Savings, investments, most loans |
The key difference
Simple interest is calculated only on the original principal, so it grows in a straight line. Compound interest is calculated on the principal and the interest already added, so it grows exponentially — interest earns interest. The longer the period and the more frequent the compounding, the bigger the gap.
Worked example
Invest 100,000 at 10% for 5 years. With simple interest you earn 100,000 × 0.10 × 5 = 50,000, for a total of 150,000. With annual compound interest you get 100,000 × (1.10)^5 − 100,000 ≈ 61,051, for a total of about 161,051 — over 11,000 more, purely from compounding.
Which matters to you?
For savings and investments, compounding works for you — start early and let it run. For borrowing, compounding works against you, which is why paying down compounding debt quickly saves so much.