Compound vs simple interest: what's the difference?

Simple interest pays only on the original amount you put in. Compound interest pays on the whole balance, including the interest you’ve already earned. That single difference is why the two look identical for a year and then pull apart for decades. And it matters more than it sounds, because almost everything you’ll meet as a consumer — savings, pensions, credit cards, mortgages — compounds. When someone quotes you a rate, assume they mean compound interest unless they specifically say otherwise.

The difference in one table

Take €10,000 earning 5% a year. Simple interest adds a flat €500 every year, forever, because it only ever counts the original €10,000. Compound interest adds 5% of whatever the balance has grown to, so the annual top-up keeps rising.

After	Compound (5% annually)	Simple (5% flat)	Gap
10 years	€16,289	€15,000	€1,289
20 years	€26,533	€20,000	€6,533
30 years	€43,219	€25,000	€18,219

At ten years the two are close. By thirty years, compound interest has produced more than €18,000 of extra growth on the same deposit at the same rate. Nothing changed except which balance the interest was calculated on.

Why the gap grows

For the very first period, simple and compound interest are the same. There’s no past interest to pay interest on yet, so both just add one slice of the rate to the principal — the original amount you started with.

The divergence begins in year two. Follow €1,000 at 5% compounded annually:

• After year 1: €1,050.00
• After year 2: €1,102.50
• After year 3: €1,157.63
• After year 10: €1,628.89

In year one you earn €50. In year two you earn €52.50 — the extra €2.50 is 5% of the €50 you already earned. In year three you earn a little more again, because now you’re earning interest on year one’s interest and year two’s interest. Simple interest would have paid a flat €50 each year, reaching just €1,500.00 after ten years. Compound reaches €1,628.89 over the same stretch.

Each year the balance is bigger, so each year’s interest is bigger, so next year’s balance is bigger still. This is why the curve steepens rather than climbing in a straight line, and why the gap doesn’t just grow but grows faster every year. It’s also why the Rule of 72 — a quick way to estimate how long money takes to double — only makes sense for compound growth. There’s no doubling time for simple interest, because the yearly gain never changes.

Which one you’re actually being offered

Compound is the default across consumer finance. Savings accounts compound. Pension pots compound. Credit card balances compound, which is why an unpaid card grows so uncomfortably fast. Mortgages compound too. If a product involves interest and doesn’t explicitly tell you it’s simple, treat the rate as compound.

The one thing to watch is how often it compounds. A rate that compounds monthly grows slightly faster than the same rate compounding annually, because the interest gets added to the balance more often. To stop this from being a hidden trap, savings rates in Ireland and across the EU are quoted as an AER — the annual equivalent rate. AER folds the compounding frequency into a single figure, so two accounts quoted at the same AER genuinely grow your money at the same speed. When you’re comparing savings, compare the AER, not the headline rate.

Where simple interest still appears

Simple interest hasn’t vanished entirely. Some short-term lending arrangements calculate interest on a simple basis, where the sum is repaid quickly enough that compounding would make little practical difference. Certain bond coupons are also quoted and paid on a simple basis, as a fixed percentage of the amount originally invested rather than of a growing balance.

These are the exceptions, and they tend to be short-term or fixed-payment by nature. The safe working assumption for anything that runs for years — the deposit you leave alone, the pension you pay into, the balance you don’t clear — is that it compounds. If a rate’s basis isn’t stated and the money is going to sit for a while, compound is the way to bet, and it’s the calculation worth understanding well.