Portrait of a young Asian woman sitting at home, doing some freelance job while taking care of her little baby boy.

Personal Loans

Simple vs. compound interest: what’s the difference?

Updated Nov 20, 2024

Aaron Crowe.jpg

Written by

Keith Osmun.jpg

Reviewed by

Key takeaways:

  • Knowing how interest rates work could help you choose a less costly loan

  • Compound interest is interest on interest

  • Simple interest is best for loans



A dollar might not change your life. But a dollar a day might. And if that dollar grows bigger every day, it could make or break your finances.

Compound interest makes the numbers grow more quickly than simple interest. If those numbers represent your savings, great. Compounding is what you want. If we’re talking about debt, not so great. Compound interest will cost you more. 

This stuff can make our brains hurt, so we asked finance expert and published author Mitchell Weiss to help us break it down. Mitchell helps non-finance people understand finance. 

Simple interest vs. compound interest

Interest is the cost of using someone else’s money. If you use your credit card issuer’s money, you pay interest. If you put money in the bank, they pay you interest. 

  • Simple interest is calculated on the amount borrowed (the principal balance)

  • Compound interest is calculated on both the principal balance and interest that has previously been added 

We’ll show you some examples using a $10,000 balance and 12% interest. Typical savings accounts don’t earn this much, and typical credit cards cost a lot more. But comparing apples to apples will make it easier to recognize how the types of interest affect your finances.

Simple interest

Simple interest is based on the amount borrowed, the interest rate, and time. Simple interest is good for borrowers. The calculation is: 

Principal x Interest rate/12 = simple interest paid per month. 

Simple interest borrowing example: Personal loan

Let’s say you take out a personal loan for $10,000 at 12% interest. Your interest charge is 1% per month (1/12th of 12%). At the end of the first month, that’s $100, so now you owe $10,100.

If you make a $300.00 payment, your new balance is $9800.00. 

In month two, you’ll only owe $98 in interest. As your balance goes down, so do your interest charges.

Simple interest savings example: Certificate of Deposit

Certificates of deposit, or CDs, are an unusual type of savings account in that they pay simple interest. CDs pay a specific amount in interest on a set date, and the money can’t be withdrawn until that date.

Invest $10,000 in a one-year CD that pays 12% interest after one year, and you’d earn $1,200 in interest. 

$10,000 x 0.12 = $1,200

Your balance would be $11,200.

This example is for informational purposes only. Interest rate and payments are for illustrative purposes only. Individual results vary.

Compound interest

Compound interest is good when you’re saving money. First, you earn interest, which increases your balance. Then you earn interest on the bigger balance. You’re earning interest on interest. 

It’s not so great for debts because you’ll pay more interest over time.

Compound interest borrowing example: credit card debt

The interest on credit cards usually compounds daily. If you owe $10,000 and the APR is 12%, you’ll owe $102.42 in interest at the end of the first month. 

Compared to our simple interest example above, it’ll cost you an additional $2.42 for the same loan with compound interest. That doesn’t seem like much, but if you think about it in terms of all of your debts, at all of their interest rates, over a span of years…the numbers snowball. 

Compound interest savings example: savings account

Here’s an example of how compound interest works when you save.

Let’s say you invest $10,000 and you earn 12% interest that’s compounded monthly (that means the interest is calculated once a month). At the end of one year, you'd have $11,268.25. 

Compared to the $11,200 that you earned in the simple interest savings example above, compounding has put you more than $68 ahead.

The beauty of compounding is that you get to earn interest on the higher balance every time interest is added. This is why financial experts always recommend that you start saving early and leave your money alone so it can grow.

This example is for informational purposes only. Interest rate and payments are for illustrative purposes only. Individual results vary.

Fun fact: the Rule of 72

You can estimate when your money will double by using the Rule of 72. You just need to know the interest rate. (This rule only works for annual compounding.)

The formula is this:

72 / interest rate = years to double your money

For example, if you expect to earn 5%, your money will double in value about every 14 1/2 years.

Author Information

Aaron Crowe.jpg

Written by

Aaron Crowe is an Achieve contributor. He is a freelance journalist who specializes in writing about personal finances. He has worked as a reporter and editor at newspapers and websites for his entire career.

Keith Osmun.jpg

Reviewed by

Keith is an editor and fact-checker for Achieve. He makes sure the content is accessible by ensuring that each piece has impeccable grammar, an approachable tone, and accurate details.

Frequently asked questions

The interest rate is the cost of borrowing money. APR, or annual percentage rate, includes the interest rate and any fees or costs of a loan. An APR is higher than an interest rate if fees are involved.

A borrower’s credit score is the primary factor lenders consider when they decide what interest rate they will offer you. Generally speaking, people with higher credit scores can qualify for lower interest rates. Other factors that could affect your rate include:

  • Loan term (shorter terms sometimes qualify for lower rates)

  • Loan amount (smaller loans sometimes qualify for lower rates)

  • Economic conditions (when market rates change, lenders change the rates they charge customers)

Compound interest is best for investors and savers because you’ll earn interest on your interest. For borrowers, compound interest can lead to paying more.

Simple interest is best for loans because you only pay interest on the principal amount you borrowed.

Related Articles

unsecured-personal-loan.jpg

Personal Loans

Use a personal unsecured loan from Achieve, with no collateral, to consolidate high-interest rate debt, make home improvements, or fund a large purchase. Apply now.

pros-cons-personal-loan-co-signer.jpg

Personal Loans

There are minor differences between a co-signer and a co-applicant and co-borrower. Both can help save money. Learn the pros and cons of using a co-signer on...

personal-loan-for-credit-card-debt.jpg

Personal Loans

Obliterate your high interest credit card debt with a low interest personal loan and get out of debt faster. Our expert tells you how.

Jackie Lam

Author

Achieve Logomark

Achieve is the leader in digital personal finance, built to help everyday people move forward on the path to a better financial future.

Footer Trust Pilot Marker

TrustScore 4.8/5

Footer BBB Marker

.

Financial solutions are offered by affiliates of Achieve.com (NMLS ID #138464) or their service providers. Terms and conditions apply. Not all solutions are available in each state.

Personal loans are available through our affiliate Achieve Personal Loans (NMLS ID #227977), originated by Cross River Bank, a New Jersey State Chartered Commercial Bank, Equal Housing Lender. Loan applications are subject to credit review, underwriting criteria, and approval. Loans are not available in all states and available loan terms/fees may vary by state. Loan amounts range from $5,000 to $50,000. For loans $35,000+ must have a minimum 660 credit score. APRs range from 8.99% to 29.99% and include applicable origination fees that vary from 1.99% to 6.99%. Repayment periods range from 24 to 60 months. Example loan: four-year $20,000 loan with an origination fee of 6.99%, a rate of 15.49%, and corresponding APR of 19.54%, would have an estimated monthly payment of $561.60 and a total cost of $26,956.80. To qualify for a 8.99% APR loan, a borrower will need excellent credit, a loan amount less than $12,000.00, and a term of 24 months. Adding a co-borrower with sufficient income; using at least eighty-five percent (85%) of the loan proceeds to pay off qualifying existing debt directly; or showing proof of sufficient retirement savings, could help you also qualify for lower rates. Funding time periods are estimates and can vary for each loan request. Same day decisions assume a completed application with all required supporting documentation submitted early enough on a day that our offices are open. Achieve Personal Loans hours are Monday-Friday 6am-8pm MST, and Saturday-Sunday 7am-4pm MST. $6,000 savings: Average savings claim for personal loans are based on 2023 data for 2, 3, and 4-year terms on funded debt consolidation loans for $21,600. Savings will vary based on several factors, subject to credit approval and other conditions. Any savings will be reflected in the offer.

© 2024 Achieve.com. All rights reserved. NMLS #138464