Calculate simple interest on a loan or deposit and see how it stacks up against compound interest over the same period.
Simple interest is calculated only on the original principal, never on previously earned interest. The formula is I = P × r × t, where P is the principal, r is the annual rate as a decimal, and t is the time in years. Because the interest base never changes, simple interest grows in a straight line rather than a curve.
Many car loans, some personal loans, and most short-term bonds use simple interest. Auto loans in particular calculate interest on the outstanding balance each day, so paying a little extra toward principal directly reduces the interest you owe. Treasury bills and many bridge loans are also quoted on a simple-interest basis.
The difference is who earns interest on the interest. With simple interest a $10,000 deposit at 5% earns exactly $500 every year. With annual compounding, year two earns 5% on $10,500, year three on more still — so the gap widens every year. Over long horizons that gap becomes enormous, which is why compounding favors savers and hurts borrowers.
Tip: When you borrow, simple interest is usually in your favor; when you save, compound interest is. Always check which method a product uses before signing.
The grey line shows a straight-line simple-interest balance, while the green line curves upward as compound interest accelerates. The longer the time period, the more the two diverge.