Simple vs. Compound Interest: How They Differ and Why It Matters

Interest is the price of using money. When you borrow, you pay it; when you save, you earn it. The rate tells you how much, but the rate alone doesn’t tell the whole story. You also need to know what the rate is applied to. With simple interest, it is applied to the original amount only. With compound interest, it is applied to the original amount plus any interest already added. That one difference produces very different results over long periods.

Simple interest: a straight line

Simple interest is calculated only on the principal, the amount originally borrowed or deposited. The formula is:

I = P × r × t

where P is the principal, r is the annual rate as a decimal and t is the time in years.

Put $10,000 into an account paying 6% simple interest and it earns $600 every year. After 5 years that’s $3,000 of interest; after 20 years, $12,000. Each year adds exactly the same amount, so a chart of the balance is a straight line.

You can run your own figures, including periods in months or days, with the simple interest calculator.

Compound interest: a curve that steepens

Compound interest adds each period’s interest to the balance. The next period’s interest is calculated on that larger balance, so you earn interest on interest. For a lump sum, the formula is:

A = P(1 + r/n)^(n × t)

where n is the number of times interest is added per year.

Take the same $10,000 at 6%, compounded once a year. Year one earns $600, just like simple interest. Year two earns 6% of $10,600, which is $636. Year three earns 6% of $11,236, which is $674.16. The yearly interest keeps growing because the balance it’s applied to keeps growing.

How the gap grows

Here’s the same $10,000 at 6%, with simple interest and with interest compounded annually:

Years	Simple interest balance	Compound interest balance	Difference
1	$10,600.00	$10,600.00	$0.00
5	$13,000.00	$13,382.26	$382.26
10	$16,000.00	$17,908.48	$1,908.48
20	$22,000.00	$32,071.35	$10,071.35
30	$28,000.00	$57,434.91	$29,434.91

After one year there is no difference, because no interest has been added yet to earn more interest. After five years compounding is ahead by less than 3%. After 30 years the compound balance is more than double the simple one. Time, more than anything else, is what makes compounding powerful.

A handy shortcut is the rule of 72: divide 72 by the annual rate to estimate how many years it takes compound growth to double your money. At 6%, that’s about 12 years (the exact figure is 11.9). With simple interest at 6%, doubling takes 100 ÷ 6, or nearly 17 years.

Compounding frequency and APY

Interest can be compounded annually, quarterly, monthly, daily or even continuously. The more often it is added, the sooner it starts earning interest of its own. On the same $10,000 at 6% for 20 years:

• Compounded annually: $32,071.35
• Compounded monthly: $33,102.04
• Compounded daily: $33,197.90

Frequency matters, but much less than the rate or the time. Because the same nominal rate gives different results at different frequencies, U.S. banks are required to disclose deposit accounts’ annual percentage yield (APY). The APY is the actual one-year growth once compounding is included. A 6% rate compounded monthly has an APY of about 6.17%. When you compare savings accounts, compare APYs.

The compound interest calculator lets you choose the compounding frequency, add monthly contributions and see the APY for any rate.

Where you’ll meet each one

Savings and investing. Savings accounts, money market accounts and CDs that leave interest in the account compound. Investments that reinvest dividends behave in a similar way, though their returns are not fixed and can be negative. A bond or CD that pays its interest out to you, rather than adding it to the balance, behaves like simple interest from the account’s point of view, unless you reinvest the payments yourself.

Loans. Many installment loans, including most auto loans, charge what lenders call simple interest. Interest accrues daily or monthly on the balance you still owe and is never added to the principal, as long as you make your payments. Because each payment reduces the balance, the interest charged each month falls over time. The guide to how loan amortization works walks through that process.

Some debts can compound. If interest goes unpaid and is added to the balance, which can happen with credit cards, some student loans during deferment, and loans with negative amortization, you end up paying interest on interest. Here compounding works against you.

Precomputed interest. Some loans calculate all of the interest up front and add it to the principal before splitting it into payments. With these loans, paying early or paying extra may not reduce the interest you owe the way it would on a simple interest loan. Ask the lender which method applies before you sign.

Questions to ask

When you see an interest rate, a few questions tell you what it really means:

1. Is it simple or compound? For savings, assume compound unless the interest is paid out. For loans, check whether unpaid interest can be added to the balance.
2. How often does it compound? Compare savings options using APY, and loans using APR, which includes certain fees.
3. What is the rate applied to? The original principal, the current balance, or a balance that includes earlier interest?
4. How long will the money be outstanding? Over a year or two, the method makes little difference. Over 30 years, it was worth almost $30,000 on the $10,000 in the table above.

Both calculators show their working, so you can check any figure a bank or lender gives you against the formula.

Sources

1. What is compound interest? — U.S. Securities and Exchange Commission, Investor.gov. Checked October 4, 2026.
2. What's the difference between a simple interest rate and precomputed interest on an auto loan? — Consumer Financial Protection Bureau. Checked October 4, 2026.
3. Appendix A to Part 1030 — Annual Percentage Yield Calculation — Consumer Financial Protection Bureau. Checked October 4, 2026.