Simple vs. compound interest: the differences
CalcuMetro editorial team · Published · 1 min read
Simple and compound interest start from the same principal and rate, but produce very different results over time. The key is what happens to the interest: whether it is paid out or reinvested.
Simple interest
Interest is always calculated on the initial principal and is not added to it.
I = P × r × t
With €10,000 at 5% a year for 10 years: I = 10,000 × 0.05 × 10 = €5,000. The final amount is €15,000.
Compound interest
Each period's interest is added to the balance and earns further interest.
A = P × (1 + r)^t (annual compounding)
With the same €10,000 at 5% for 10 years: A = 10,000 × 1.05^10 = €16,288.95. Interest totals €6,288.95, which is €1,288.95 more than with simple interest.
Comparison after 1, 10 and 20 years
- 1 year: €500 of interest in both cases, because there is no accumulated interest to reinvest yet.
- 10 years: €5,000 with simple interest versus €6,288.95 with compound interest.
- 20 years: €10,000 with simple interest versus €16,532.98 with compound interest.
The gap grows over time because, with compound interest, each year's interest is calculated on a larger balance.
When each one is used
Simple interest appears in short-term calculations or when interest is paid out instead of reinvested. Compound interest describes how savings and investments grow when returns are reinvested, and also how a debt grows when unpaid interest is added to the balance.
Educational content with illustrative examples; not financial, tax or legal advice.