Compound vs. Simple Interest: What’s the Difference?
Compound interest helps you earn more on your investments, while simple interest helps you save when repaying your loans. Learn even more about compound interest vs. simple interest, and how to help you work the system to your advantage.
When it comes to investing and borrowing, the most important thing you need to care about is interest. Understanding how interest applies to you will help you more on your investments and save you more on your debts.
There are two different types of interest you should know about. Compound interest and simple interest. We’re going to explain the difference between the two and show you how knowing the difference can get you earning more and keep you out of debt.
What is simple interest?
Simple interest for loans
Simple interest is a loan payment plan where you are charged interest based on the amount of time you take out the loan.
Simple is typically used on auto or personal loans, and it is calculated by multiplying the interest rate (as a decimal) by the principal balance and the number of years you take out your loan/investment.
Simple interest = P x R x N
Simple interest is best for people who can pay their entire monthly balance, or pay early. Shortening the days between payments will reduce the principal balance faster and help you save money in interest payments over the life of the loan.
Simple interest in investing
For investments, on the other hand, simple interest isn’t as advantageous because it accrues value only on your original investment amount.
For example, if you invest $1,000 at 5% interest, you earn $50 in interest the first year. In the second year, you would earn another $50 on your original investment, and so on. While you continue to earn money on your investment, it is a slow and steady rise that doesn’t deliver high returns since you receive the same amount of money every year.
What is compound interest?
Compound interest in investment
Compound interest allows you to earn interest on interest when investing, making you more money in the long run.
Compound interest can have different compounding frequencies, ranging from every day to once a year. The more often your interest compounds, the more money you earn. For example, if you invest $1,000 in a compound interest savings account with 5% annual interest (a rarity today), you would earn $50 at the end of the year. In the second year, you would earn interest on the full balance of $1,050 for $52.50 in interest, and so on.
To calculate the amount of your compound interest, you take the principal balance and multiply it by the interest, plus one, and raise it to the number of compounding periods minus one. The equation looks like this:
P [(1 + i)^n – 1]
- P = Principal
- i = annual interest rate in percent
- n = number of compounding periods
Compound interest for loans
While compound interest is beneficial when you’re investing because it earns you more money, it can also work against you when borrowing money.
Over the life of the loan, you will end up paying more money in the long run on a compound interest loan. As the interest accumulates, it is rolled into the loan’s principal balance. This is how most credit cards can get you. Some of the worst offenders compound interest every day you’re late.
How can you calculate simple interest from compound interest?
As you can see it’s easier to convert to APY from APR than back.
APR = =P×I×N
P = Principal
i = annual interest rate in percent
n = time in years
APY= (1 + r/n )^n – 1
- R = the stated APR as a decimal
- n = the number of compounding periods each year.
While your best bet is usually to find an online calculator, you can find your APR rate from your APY by following this process:
How to convert
- Convert your APY to a decimal (10.5% is .105)
- Add 1 (1.105)
- Raise to the 1/N power. N=the number of compounding periods each year.
- Subtract 1
- Multiply by N
- Multiply by 100
Check out the article we wrote on APR vs. APY for a more in-depth look.
Where to invest for compound or simple interest
Investment platforms like MyConstant offer both compound and simple interest investments.
As a P2P platform, MyConstant connects borrowers and investors around the world. You can invest cryptocurrency assets and earn interest, or use your crypto as collateral to borrow.
MyConstant crypto-backed investments allow you to lend your cryptocurrency or USD and earn 7% APR (simple interest). All loans are backed by collateral, so it’s a low-risk option for earning impressive returns. You even get to choose the terms yourself. Once you invest, you’ll earn simple interest on the principal amount, making it an easy way to use your idle crypto assets to bring in more.
Plus, you can always take your total principal and interest balance and reinvest to simulate compound interest.
The MyConstant Flex investment delivers 50x better interest than a normal savings account. With Flex, you can earn up to 4% APY in compound interest through decentralized lending and liquidity pools. Your interest is compounded and paid every second with unlimited withdrawals and no hidden fees.
Sound good? Sign up for a free account and start doing more with your money today.
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