Simple Interest vs. Compound Interest: What's the Difference?
Edited by Aimie Carlson || By Janet White || Published on November 1, 2023
Simple Interest is calculated only on the principal amount, whereas Compound Interest is calculated on both the principal and previously earned interest.
Key Differences
Simple Interest is a straightforward method of determining how much extra money you'll owe or earn over time based solely on the initial sum, or principal. On the other hand, Compound Interest considers not only the principal but also the interest that has been added to that principal, leading to "interest on interest."
For short-term loans or investments, Simple Interest can be more commonly used because the principal doesn't change. Compound Interest is typically applied to long-term scenarios since it can exponentially grow over time due to the accumulating interest on previous interest.
If you were to invest or borrow a fixed sum of money, with Simple Interest, the interest amount remains constant every period, be it monthly, quarterly, or annually. In contrast, with Compound Interest, the interest amount grows each period, as it's calculated on the new, larger principal.
One of the critical differences between Simple Interest and Compound Interest lies in their calculations. For Simple Interest, you multiply the principal by the rate and the time. But for Compound Interest, you need to consider the frequency of compounding and apply the formula accordingly.
Over extended periods, the effects of Simple Interest might seem negligible when compared to Compound Interest. Simple Interest offers linear growth, while Compound Interest provides exponential growth, making the latter more beneficial for investors but costlier for borrowers.
ADVERTISEMENT
Comparison Chart
Basis of Calculation
Principal only
Principal and accumulated interest
Growth Pattern
Linear
Exponential
Frequency of Calculation
Typically once
Can be daily, monthly, annually, etc.
Common Usage
Short-term loans or investments
Long-term loans, investments, savings accounts
End Result Over Time
Amount grows steadily
Amount grows at an increasing rate
ADVERTISEMENT
Simple Interest and Compound Interest Definitions
Simple Interest
Calculation considering only the principal amount.
I prefer investments with Simple Interest for their straightforward returns.
Compound Interest
Interest that compounds based on frequency set (daily, monthly, annually).
The power of Compound Interest in my retirement account ensures a comfortable future.
Simple Interest
A method where interest accrues only on the initial amount.
With Simple Interest, my savings account grew by a fixed amount each year.
Compound Interest
A method where interest is earned on interest.
Savings accounts often use Compound Interest, benefiting savers in the long run.
Simple Interest
Interest computed only on the original principal.
I earned $200 as Simple Interest on my $1000 loan over two years.
Compound Interest
Accumulation of interest on both initial sum and previously earned interest.
Compound Interest makes long-term loans more expensive due to interest on interest.
Simple Interest
Linear growth based on the starting amount.
My bond uses Simple Interest, so I know exactly how much I'll receive yearly.
Compound Interest
Interest calculated on the initial principal, which also includes accumulated interest.
My investment grew significantly due to Compound Interest over the years.
Simple Interest
Interest that doesn't compound over time.
The Simple Interest on my short-term loan made repayments predictable.
Compound Interest
Exponential growth as interest is added back to the principal.
Thanks to Compound Interest, my deposit doubled faster than expected.
FAQs
What's the main difference between Simple Interest and Compound Interest?
Simple Interest is calculated only on the principal, whereas Compound Interest includes interest on previously earned interest.
How often is Compound Interest applied to an amount?
Compound Interest can be applied daily, monthly, quarterly, annually, or as per the set frequency.
Which interest type results in more earnings for savers?
Savers generally earn more with Compound Interest compared to Simple Interest over long durations.
Is Simple Interest calculated daily?
Typically, Simple Interest is calculated once for the entire duration, not daily.
How is the growth pattern different for both interest types?
Simple Interest provides linear growth, whereas Compound Interest offers exponential growth.
Can Compound Interest be disadvantageous?
For borrowers, Compound Interest can lead to significantly higher costs over time compared to Simple Interest.
Why is Compound Interest called "interest on interest"?
Because Compound Interest is calculated on the initial principal and the accumulated interest.
Is Simple Interest beneficial for long-term investments?
For long-term investments, Compound Interest usually offers greater returns than Simple Interest.
Why might some prefer Simple Interest?
Simple Interest is straightforward, predictable, and doesn't compound over time, making calculations and projections easier.
Does Compound Interest always result in more interest than Simple Interest?
Over extended periods, Compound Interest typically results in more interest than Simple Interest.
Why do borrowers pay more over time with Compound Interest?
Borrowers pay more because Compound Interest accumulates "interest on interest," increasing the owed amount.
Which interest type is more complex to calculate?
Compound Interest requires more complex calculations, especially with varying compounding frequencies, compared to Simple Interest.
How does time affect the impact of Compound Interest?
Over longer durations, the effects of Compound Interest become more pronounced, leading to exponential growth.
How do the effects of Compound Interest become significant?
As interest compounds over time, especially at higher frequencies, the effects of Compound Interest become significantly apparent.
In which scenarios is Simple Interest commonly used?
Simple Interest is often used in short-term loans or scenarios where the principal remains unchanged.
How is the final amount determined using Simple Interest?
The final amount with Simple Interest is the sum of the principal and the interest calculated on that principal.
Do most savings accounts use Simple or Compound Interest?
Most savings accounts utilize Compound Interest to benefit account holders over time.
Can Compound Interest be disadvantageous for investors?
If an investor borrows money at a rate with high Compound Interest, it can be costlier in the long run.
What happens if Compound Interest is compounded more frequently?
The more frequently Compound Interest is compounded, the greater the overall interest accumulated.
Why is Compound Interest considered powerful for wealth growth?
Compound Interest can lead to exponential growth, making money work harder and grow faster over time.
About Author
Written by
Janet WhiteJanet White has been an esteemed writer and blogger for Difference Wiki. Holding a Master's degree in Science and Medical Journalism from the prestigious Boston University, she has consistently demonstrated her expertise and passion for her field. When she's not immersed in her work, Janet relishes her time exercising, delving into a good book, and cherishing moments with friends and family.
Edited by
Aimie CarlsonAimie Carlson, holding a master's degree in English literature, is a fervent English language enthusiast. She lends her writing talents to Difference Wiki, a prominent website that specializes in comparisons, offering readers insightful analyses that both captivate and inform.
