7 min read · Free educational guide
Simple vs compound interest
Simple interest pays only on the original principal. Compound interest pays on principal plus accumulated interest — “interest on interest.” Over long periods, compounding is why savings and debt can grow faster than intuition suggests.
Standard compound interest formula
A = P (1 + r/n)^(n t), where A is the amount, P is principal, r is the annual rate as a decimal, n is compounding periods per year, and t is time in years.
Example: $1,000 at 5% annual interest compounded monthly for 3 years → A = 1000 × (1 + 0.05/12)^(12×3) ≈ $1,161.47.
Why frequency matters
More frequent compounding (monthly vs yearly) slightly increases effective growth for the same nominal annual rate. Loans and savings accounts should state both the nominal rate and the compounding schedule.
Using calculators responsibly
Online calculators are educational estimates. Real bank products may include fees, variable rates, or day-count conventions. Always read the product terms for decisions about borrowing or investing.
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FAQ
- What is APY?
- Annual percentage yield reflects compounding; it can be higher than the nominal interest rate when interest compounds more than once per year.
- Does compound interest work against me on loans?
- It can, when unpaid interest is added to the balance. Paying down principal faster reduces future interest.