Simple vs Compound: The Two Ways Interest Works
All interest answers one question — what does money earn (or cost) over time? — but two different rules produce very different outcomes:
- Simple interest is always computed on the original principal only. Earnings are linear: the same amount every period, forever.
- Compound interest is computed on principal plus accumulated interest. Earnings accelerate as the base grows.
This calculator runs both on identical inputs and shows the gap — small over months, decisive over decades. Knowing which rule applies to a product you're offered (loan, bond, savings account, friendly IOU) is genuinely valuable consumer knowledge.
The Formulas
Simple interest
Compound interest
Where P = principal, r = annual rate (decimal), t = years, n = compounding periods per year.
Worked example — $10,000 at 6% for 10 years
| Simple | Compound (monthly) | |
|---|---|---|
| Interest earned | $6,000 | $8,194 |
| Final amount | $16,000 | $18,194 |
| Compounding advantage | $2,194 (+37% more interest) | |
Where Each Type Shows Up in Real Life
| Product | Usually | Note |
|---|---|---|
| Savings accounts, CDs | Compound | Often daily or monthly compounding |
| Credit cards | Compound (daily) | Compounding works against you |
| Mortgages, auto loans | Amortized | Interest on remaining balance — see Loan Calculator |
| Auto/short personal loans (some) | Simple | "Simple interest loan" — interest accrues daily on balance |
| Bonds (coupon) | Simple payout | Compounds only if you reinvest coupons |
| Treasury bills, some notes | Simple/discount | Short horizons make the difference minor |
The label matters most on long products: a 10-year "simple interest" investment at 6% badly trails a compound one at the same quoted rate.
How Time Stretches the Gap
$10,000 at 6%, simple vs monthly compound:
| Years | Simple | Compound | Gap |
|---|---|---|---|
| 1 | $10,600 | $10,617 | $17 |
| 5 | $13,000 | $13,489 | $489 |
| 10 | $16,000 | $18,194 | $2,194 |
| 20 | $22,000 | $33,102 | $11,102 |
| 30 | $28,000 | $60,226 | $32,226 |
Over one year the difference is a rounding error; over thirty it's triple the original principal. For the deep dive on compounding with contributions, continue to the Compound Interest Calculator.
Practical Takeaways
- Ask "simple or compound, and how often?" for any product quoted with a rate — the same 6% can mean meaningfully different outcomes.
- For savings, prefer compounding (and more frequent is mildly better at equal rates).
- For debts, compounding is the enemy — daily-compounding card balances grow faster than most intuitions expect.
- Compare products by APY, not APR, when frequencies differ — APY bakes the compounding in (convert with the Interest Rate Calculator).
- Short horizons forgive, long horizons punish: the rule you're under barely matters for 6 months and matters enormously for 30 years.
The Bottom Line
Same principal, same rate, same years — and outcomes thousands apart, purely from the compounding rule. Run your own numbers above and check the gap line: that's the price of not asking how interest is calculated, and the reward for putting time on the compounding side of your money.