Simple Interest vs Compound Interest: What's the Real Difference?
A clear comparison of simple and compound interest with worked examples showing how £10,000 grows differently under each method, and when each type applies.
The real difference between simple and compound interest is whether you earn interest on your interest. With simple interest, you earn a fixed amount each year based only on the original sum. With compound interest, each year’s interest is added to the balance, so the following year you earn interest on a larger amount. Over time, this creates a dramatic gap.
Try both with our Simple Interest Calculator and Compound Interest Calculator.
The Two Formulas
Simple interest:
Interest = P × r × tCompound interest:
A = P × (1 + r/n)^(n × t)Where P is the principal, r is the annual rate (as a decimal), t is time in years, and n is how many times interest compounds per year.
Side-by-Side: £10,000 at 5% for 10 Years
| Year | Simple interest balance | Compound interest balance (annual) |
|---|---|---|
| 0 | £10,000 | £10,000 |
| 1 | £10,500 | £10,500 |
| 3 | £11,500 | £11,576 |
| 5 | £12,500 | £12,763 |
| 7 | £13,500 | £14,071 |
| 10 | £15,000 | £16,289 |
After 10 years, simple interest has earned you £5,000. Compound interest has earned you £6,289 — an extra £1,289 from the same rate and the same starting amount. The gap widens further over longer periods: at 20 years, simple interest gives £20,000 while compound interest gives £26,533.
Why the Gap Grows
With simple interest, you earn exactly £500 every year — no more, no less. With compound interest, your first year also earns £500, but the second year earns £525 (5% of £10,500), the third year earns £551, and so on. Each year’s earnings are slightly larger than the last.
This is exponential growth versus linear growth, and the longer the time period, the more it matters.
When Each Type Applies
Simple interest is used for:
- Short-term personal loans
- Some car finance agreements
- Government bonds and certain fixed-income products
- Calculations where interest is not reinvested
Compound interest is used for:
- Savings accounts (interest is typically compounded daily or monthly)
- ISAs and investment accounts
- Mortgages (interest compounds on the outstanding balance)
- Credit cards (interest compounds on unpaid balances — working against you)
Most real-world financial products use compound interest. When a bank advertises an interest rate on a savings account, the AER (Annual Equivalent Rate) already accounts for compounding, so you can compare products directly.
Making Compound Interest Work for You
Three things amplify compound interest: a higher rate, more frequent compounding, and — most importantly — more time. Starting 10 years earlier has a far greater impact than increasing your interest rate by a percentage point.
Use the Savings Calculator to model how regular contributions interact with compound interest over time. Even modest monthly deposits can grow substantially over decades.