Simple vs Compound Interest: Formulas and Examples
Short answer. Simple interest is calculated only on the original principal: $1,000 at 5% earns $50 every year. Compound interest is calculated on the principal plus the interest already earned, so the same $1,000 grows to about $1,629 after 10 years instead of $1,500. The longer the time and the higher the rate, the bigger the gap.
Side by side
| Compound interest | Simple interest (see interest rate) | |
|---|---|---|
| Interest earned on | Principal only | Principal plus accumulated interest |
| Formula | A = P (1 + r t) | A = P (1 + r/n)^(n t) |
| $1,000 at 5% for 10 years | $1,500 | About $1,629 (annual compounding) |
| Growth shape | Straight line | Exponential curve |
| Common in | Some short-term loans, bonds’ coupon calculation, car loans | Savings accounts, investments, credit cards, mortgages |
| Works for you when | Borrowing | Saving and investing |
| Works against you when | Saving | Borrowing at high compounding rates, e.g. credit cards |
Which one fits you?
Lean towards Compound interest if…
- you are checking a short loan quoted with simple interest
- you want an easy baseline for comparison
Lean towards Simple interest (see interest rate) if…
- you are saving for the long term and want reinvested returns
- you are estimating how a card balance grows if unpaid
Frequently asked questions
How can I estimate doubling time?
Use the rule of 72: divide 72 by the annual rate. At 6%, money doubles in about 12 years.
Does compounding frequency matter?
Yes, slightly: monthly compounding grows faster than annual at the same rate, but the effect is small compared with time and rate.
Which do mortgages use?
Most mortgages accrue interest on the outstanding balance and amortise it monthly.
General education, not personal financial advice. Figures are typical US examples and vary by provider and year.