Simple vs. Compound Interest
Understand the key differences and how they impact your finances
Simple Interest
Simple interest is calculated only on the initial principal amount for the entire duration of a loan or investment.
I = P × r × t
Where:
- I = Interest
- P = Principal (initial amount)
- r = Annual interest rate (in decimal)
- t = Time (in years)
Example: If you invest $1,000 at 5% annual simple interest for 3 years:
Interest = 1000 × 0.05 × 3 = $150
Total = $1,000 + $150 = $1,150
Compound Interest
Compound interest is calculated on the initial principal and also on the accumulated interest from previous periods.
A = P × (1 + r/n)nt
Where:
- A = Final amount
- P = Principal (initial amount)
- r = Annual interest rate (in decimal)
- n = Number of compounding periods per year
- t = Time (in years)
Example: If you invest $1,000 at 5% annual interest compounded annually for 3 years:
Year 1: $1,000 × 1.05 = $1,050
Year 2: $1,050 × 1.05 = $1,102.50
Year 3: $1,102.50 × 1.05 = $1,157.63
Key Differences
| Aspect | Simple Interest | Compound Interest |
|---|---|---|
| Calculation Basis | Only on principal amount | On principal + accumulated interest |
| Growth Pattern | Linear (straight line) | Exponential (curved line) |
| Interest Earned | Lower | Higher over time |
| Formula | I = P × r × t | A = P × (1 + r/n)nt |
| Best For | Borrowers (e.g., car loans) | Investors (e.g., savings accounts) |
Interest Calculator
Simple Interest
$1,150.00
Total Interest: $150.00
Compound Interest
$1,157.63
Total Interest: $157.63
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