Banks love to say 'interest', but there are two very different kinds. The difference between simple and compound interest can mean thousands of dollars โ for or against you.
Simple Interest
Interest calculated only on the original amount (principal), every period.
Interest = Principal ร Rate ร Time
Example
$1,000 at 5% simple interest for 3 years:
- Year 1: $50 ยท Year 2: $50 ยท Year 3: $50
- Total earned: $150
Compound Interest
Interest on principal + previously earned interest. Your money grows on itself.
A = P ร (1 + r/n)^(nรt)
Example
$1,000 at 5% compounded annually for 3 years:
- Year 1: $50 โ $1,050
- Year 2: $52.50 โ $1,102.50
- Year 3: $55.13 โ $1,157.63
- Total earned: $157.63
The Long-Term Difference
| Time | Simple (5%) | Compound (5%) | Difference |
|---|---|---|---|
| 10 years | $1,500 | $1,629 | +$129 |
| 20 years | $2,000 | $2,653 | +$653 |
| 30 years | $2,500 | $4,322 | +$1,822 |
When It Works Against You
On loans and credit cards, compound interest works in the lender's favor. A 20% APR credit card compounds monthly โ that's why balances balloon so fast.
Try Our Calculators
- Compound Interest Calculator โ see your money grow with a chart
- Credit Card Payoff Calculator โ plan your escape from compound interest
- Investment Calculator โ project long-term portfolio growth
In debt? The order you attack your balances matters โ read our Debt Avalanche vs. Debt Snowball guide to pick the cheapest payoff strategy.
๐ก Pro Tip: The earlier you start saving, the more compounding works for you. Start with anything โ even $50 a month.
*See compounding in action with our free Compound Interest Calculator.*
