Quick Comparison
| Simple Interest | Compound Interest | |
|---|---|---|
| Interest calculated on | Principal only | Principal + accumulated interest |
| Growth pattern | Linear (straight line) | Exponential (accelerating curve) |
| Formula | I = P × r × t | A = P(1 + r/n)^nt |
| $10k at 6% for 30 yrs | $28,000 | $60,226 (monthly) |
| Best for savers | No | Yes |
| Common in | Short-term loans, car loans | Savings accounts, mortgages, credit cards |
Simple Interest: Formula and How It Works
Simple interest is calculated only on the original principal, not on any accumulated interest. The formula is:
- I
- Interest earned
- P
- Principal (initial amount)
- r
- Annual interest rate (decimal)
- t
- Time in years
Example: $10,000 at 6% for 10 years (simple interest):
I = 10,000 × 0.06 × 10 = $6,000
Final balance = $10,000 + $6,000 = $16,000
Notice: you earn exactly $600 in interest every single year, regardless of how long you've held the investment. That's the "linear" nature of simple interest.
Compound Interest: Formula and How It Works
Compound interest adds earned interest back to the principal, so the next period's interest is calculated on a larger base. The formula is:
- A
- Final amount
- P
- Principal
- r
- Annual rate (decimal)
- n
- Compounding periods per year
- t
- Time in years
Same example: $10,000 at 6% for 10 years, compounded monthly:
A = 10,000 × (1 + 0.06/12)^(12×10) = $18,193.97
That's $2,193.97 more than simple interest — on the same deposit, same rate, same period.
Side-by-Side Over 30 Years ($10,000 at 6%)
| Year | Simple Interest Balance | Compound Interest (Monthly) | Compound Advantage |
|---|---|---|---|
| 1 | $10,600 | $10,616.78 | +$16.78 |
| 5 | $13,000 | $13,488.50 | +$488.50 |
| 10 | $16,000 | $18,193.97 | +$2,193.97 |
| 15 | $19,000 | $24,540.94 | +$5,540.94 |
| 20 | $22,000 | $33,102.04 | +$11,102.04 |
| 25 | $25,000 | $44,650.16 | +$19,650.16 |
| 30 | $28,000 | $60,225.75 | +$32,225.75 |
After 30 years the compound interest account has more than double the simple interest balance — from the same $10,000 investment.
Which Is Better for Savers?
Compound interest is overwhelmingly better for savers. The longer you save, the bigger the gap. Almost all savings products in the US — high-yield savings accounts, CDs, money market accounts, investment accounts — pay compound interest.
Always look for the highest APY (Annual Percentage Yield), which already reflects the compounding frequency. Two accounts with the same stated rate can have different APYs depending on how often they compound.
Which Is Better for Borrowers?
Simple interest is better for borrowers — it's cheaper. However, most significant debt (mortgages, student loans, credit cards) uses compound interest. The type that really hurts borrowers is daily compounding at high rates:
| Debt type | Typical rate | Compounding | $5,000 after 5 yrs (no payments) |
|---|---|---|---|
| Car loan (simple) | 7% | Simple | $6,750 |
| Personal loan | 12% | Monthly | $9,083 |
| Credit card | 22% | Daily | $15,022 |
| Payday loan | 400%+ | Daily | Astronomical |
Credit card debt compounding daily at 22% turns $5,000 into over $15,000 in just 5 years — and nearly $45,000 in 10 years. Pay more than the minimum, and prioritize high-rate debt first.
Real-World Examples of Each
Simple interest is used in:
- Most auto loans
- Short-term personal loans
- Some bonds (interest paid at maturity, not reinvested)
- Treasury bills
Compound interest is used in:
- High-yield savings accounts (daily or monthly)
- Certificates of deposit (CDs)
- Mortgages (monthly amortization)
- Credit cards (daily compounding)
- Student loans (capitalizing interest)
- 401(k) and IRA investment returns