Interest comes in two flavours, and the difference compounds — literally — into tens of thousands of dollars over time. This guide explains simple versus compound interest with the formulas, a side-by-side example, and where you'll meet each one in real life.
The quick answer
Simple interest is calculated only on your original amount (the principal). Compound interest is calculated on the principal plus all the interest already earned — so you earn interest on your interest. Over short periods the two are almost identical; over years, compound interest pulls dramatically ahead. That's wonderful when you're saving and painful when you're borrowing.
Simple interest
Simple interest grows in a straight line. The interest each period is the same, because it's always a fixed percentage of the original principal.
Formula: Interest = Principal × rate × time. So $10,000 at 7% for 3 years earns 10,000 × 0.07 × 3 = $2,100, for a balance of $12,100. Every year adds exactly $700 — no more, no less.
Compound interest
Compound interest grows exponentially, because each period's interest is added to the balance and then earns interest itself the next period.
Formula: A = P(1 + r/n)^(nt), where r is the annual rate, n is how many times a year it compounds, and t is years. $10,000 at 7% compounded annually for 3 years is 10,000 × 1.07³ ≈ $12,250 — about $150 more than simple interest after just three years, and the gap widens fast.
Side-by-side: $10,000 at 7%
| Years | Simple interest | Compound interest |
|---|---|---|
| 10 | $17,000 | $19,672 |
| 20 | $24,000 | $38,697 |
| 30 | $31,000 | $76,123 |
After 30 years, compounding more than doubles the simple-interest result — same deposit, same rate. The only difference is that compound interest kept reinvesting the interest.
The Rule of 72
A handy shortcut: divide 72 by your annual rate to estimate how many years it takes compound interest to double your money. At 7%, that's 72 ÷ 7 ≈ 10.3 years to double — and double again about every decade after that. Simple interest has no such doubling effect; it just adds the same amount forever.
Where each one shows up
- Compound interest: savings accounts, investments, retirement funds, credit-card balances, and most mortgages. It works for you when saving and against you when carrying debt.
- Simple interest: some car loans, short-term personal loans, and certain bonds, where interest is charged only on the original principal.
This is also why paying down high-interest debt early is so powerful — you stop compounding from working against you. See how extra mortgage payments save thousands for that idea in action.
Make compounding work for you
Start early, contribute regularly, and let time do the heavy lifting. Model any scenario — rate, frequency, and monthly contributions — with the Compound Interest Calculator, or work backwards from a target with the Savings Goal Calculator. For a deeper walkthrough, read compound interest explained.