| Simple Interest | Compound Interest | |
|---|---|---|
| How it works | Interest calculated on original principal only | Interest calculated on principal + previously earned interest |
| Growth shape | Linear (straight line) | Exponential (curves upward) |
| Common use | Short-term loans, car loans | Mortgages, savings, investments, credit cards |
| Formula | P × r × t | P × (1 + r/n)^(n×t) |
| Better for borrower? | Yes — costs less over time | No — more expensive over time |
| Better for saver? | No — earns less | Yes — earns more over time |
With simple interest, $10,000 at 5% earns $500 every year, no more. With compound interest at the same 5%, compounded annually, the first year still earns $500 -- but the second year earns $525, because it calculates interest on $10,500. Each year the base grows, and so does the interest.
When the gap starts to matter
For short time periods the difference is small enough to ignore for most practical purposes. Over years and decades the gap becomes very large. That is why compound interest is described as the key mechanism behind long-term investing -- the returns from previous years generate their own returns, accelerating growth. It is also why carrying credit card debt is so expensive over time.
The compound interest calculator lets you see the two curves side by side for your own numbers, so you can see exactly when and by how much the compounding effect overtakes simple interest for a specific principal, rate, and term.