- What's the actual difference between simple and compound interest?
- Simple interest is earned only on the original balance, so it adds the same dollar amount every period. Compound interest is earned on the balance plus any interest already added, so the dollar amount grows every period. On $10,000 at 5% for 10 years, simple interest totals $15,000.00, while interest compounded monthly totals $16,470.09 — $1,470.09 more, from the same starting balance and rate.
- Does the gap between them grow over time?
- Yes, and it accelerates. At 5 years the compounding advantage is only $333.59, but by 30 years it has grown to $19,677.44 — far more than 6× the 5-year gap, even though the time span is only 6× longer. That's because each year's extra interest itself starts earning interest.
- Which one is better for me?
- It depends which side of the balance you're on. As a saver or investor, compound interest is better — it's why savings accounts, CDs, and investment growth are usually quoted as compounding. As a borrower, compound interest works against you, since unpaid interest can itself start accruing interest; that's why credit card balances that go unpaid can grow so quickly.
- Where is simple interest actually used?
- Some short-term loans, auto loans, and certain bonds use simple interest, calculated only on the original principal for the life of the loan. Most savings accounts, credit cards, and mortgages use compound interest instead, so it's worth checking which one applies before comparing two offers by their rate alone.