Simple interest

With simple interest the interest is always calculated on the amount originally put in. It makes no difference how much you have already earned: the base stays the same. As a result the value grows evenly, by exactly the same amount every year.

It is the simplest possible model of interest. Which is precisely why, in practice, it is only used for short periods.

The formula

$$A = P \times (1 + r \times t)$$

• $A$: the amount at the end
• $P$: the amount originally put in
• $r$: the annual interest rate as a decimal (0.05 for 5%)
• $t$: the number of years

Notice that $t$ is a plain multiplier in the formula. That is the whole difference from compound interest, where it sits in the exponent.

The difference from compound interest

This is the one thing to take away from this entry. With compound interest the interest credited is added to the principal and earns alongside it next time. With simple interest it is never added.

€1,000 at 5% a year

After	Simple interest	Compound interest
10 years	€1,500	€1,628.89
20 years	€2,000	€2,653.30

After ten years the gap is just under €129. After twenty it is more than €650, and it widens ever faster with each year that follows.

Over a short horizon the difference is negligible. Over a long one it is decisive, which is why all long-term saving and investing is calculated with compound interest.

What it means in practice

You will rarely meet pure simple interest, and almost always only over short periods: some term deposits of up to a year, penalties and default interest, or short-term loans between individuals.

If someone offers you a long-term product on simple interest, it is a worse offer than it looks. And conversely, if you are the one borrowing, simple interest is in your favour.

Try it yourself

In the compound interest calculator you can see how far the compound curve pulls away from the straight line simple interest would draw.