Which is better, simple or compound interest?
Compound is better when you are earning and worse when you are borrowing. Most savings and investments compound; some car and personal loans use simple interest, which favours the borrower.
Compare simple and compound interest on any deposit or loan, and see how compounding frequency changes the total you earn or owe.
Simple interest = P × r × t. Compound interest = P × (1 + r/n)^(n×t) − P, where n = compounding periods per year.
$5,000 at 6% for 10 years earns $3,000 simple interest, but $4,098 compounded monthly — an extra $1,098 from compounding alone.
Compound is better when you are earning and worse when you are borrowing. Most savings and investments compound; some car and personal loans use simple interest, which favours the borrower.
It matters more at higher rates. At 6% the gap between annual and daily compounding over 10 years is about 2% of the balance; at 20% APR on a card it becomes substantial.
APY includes compounding, APR does not. A 12% APR compounded monthly is a 12.68% APY — always compare deposit accounts on APY and loans on APR plus fees.