Understanding Simple vs. Compound Interest
Interest is the cost of borrowing money or the return on an investment. Our Interest Calculator can handle both simple and compound interest, two fundamental concepts in finance. Understanding the difference is key to making smart financial decisions, whether you're saving money or taking out a loan.
Simple Interest
Simple interest is calculated only on the original principal amount. It's a straightforward calculation that doesn't account for interest earning interest.
Compound Interest
Compound interest is "interest on interest." It is calculated on the initial principal and also on the accumulated interest from previous periods. This can significantly accelerate the growth of your savings or the cost of your debt over time.
The Formulas Behind the Interest Calculator
Simple Interest Formula
A = P(1 + rt)- A = Final Amount
- P = Principal Amount (the initial sum)
- r = Annual Interest Rate (in decimal form)
- t = Time Period (in years)
Compound Interest Formula
A = P(1 + r/n)^(nt)- A = Final Amount
- P = Principal Amount
- r = Annual Interest Rate (in decimal form)
- n = Number of times interest is compounded per year
- t = Time Period (in years)
Practical Example: The Power of Compounding
Let's see the difference. Imagine you invest $1,000 for 10 years at an annual interest rate of 5%.
With Simple Interest:
A = 1000(1 + 0.05 * 10) = 1000(1.5) = $1,500- You earn $500 in interest.
With Compound Interest (compounded annually, n=1):
A = 1000(1 + 0.05/1)^(1*10) = 1000(1.05)^10 ≈ $1,628.89- You earn $628.89 in interest.
As you can see, compounding earns you an extra $128.89 over the same period. The more frequently interest is compounded (e.g., monthly or daily), the faster your investment will grow.