- Simple interest is calculated only on the original amount. Compound interest includes accumulated interest too.
- Over time, compound interest will always produce a higher return at the same rate.
- The difference grows dramatically over longer time periods.
- Understanding both types helps you make smarter decisions about savings and borrowing.
The Core Difference in One Sentence
Simple interest pays you on what you originally put in. Compound interest pays you on what you originally put in plus everything it has already earned. That one difference is responsible for a surprisingly large gap in outcomes over time.
Simple Interest vs Compound Interest: Side by Side
| Simple Interest | Compound Interest | |
|---|---|---|
| Calculated on | Original principal only | Principal plus accumulated interest |
| Growth pattern | Linear and predictable | Exponential and accelerating |
| Annual interest | Always the same amount | Increases over time |
| Best for | Short term lending or borrowing | Long term saving and investing |
| Common uses | Some personal loans, car finance | Savings accounts, ISAs, investments |
A Real Numbers Example: £5,000 Over 20 Years
With Simple Interest
Each year you earn 5% of £5,000, which is £250. After 20 years, total interest is £5,000. Your balance is £10,000.
With Compound Interest (Annual)
In year one you also earn £250. But in year two you earn 5% of £5,250 = £262.50. After 20 years your balance reaches approximately £13,266 — over £3,200 more.
Why Time Is the Secret Ingredient
Over one or two years, the difference is barely noticeable. But compounding is built for marathons. The effect accelerates because each period adds to an increasingly larger base. After five years the gap is modest. After thirty years, it can represent thousands of pounds.
Where You Will Find Each Type
Simple Interest
Certain personal loans, car finance agreements, and some bonds. The interest is calculated on the original amount and does not change.
Compound Interest
Most savings accounts, ISAs, mortgages, credit cards, and investments. When you see an AER on a savings account, that figure already reflects compounding.
Benefits and Disadvantages
Compound Interest
Simple Interest
Which Type Should You Look For?
If you are saving or investing, compound interest is almost always preferable. Look for accounts that compound monthly or daily. If you are borrowing, simple interest is generally kinder to your wallet.