How this number is made
Simple interest pays the rate on the original principal only. Compound interest pays the rate on the principal and on earlier interest. This page compounds once a year so the comparison is clean. A bank that compounds daily will pay a bit more than the compound column. Monthly additions belong on the compound-interest page.
- The principal stays put. Do not add deposits.
- The rate is the annual rate, not a monthly rate.
Formula
Simple = principal × rate × years. Compound = principal × (1 + rate) ^ years − principal.
Worked example
With the figures already in the form, compound interest is $3,144.
Questions
Which one does a savings account use?
Compound, usually more often than once a year. Simple interest shows up in some short-term notes and in textbook comparisons.
Why is the gap small at first?
Compounding needs earlier interest to earn on. Over a short term the two are close. Over a long term they are not.