The difference between simple interest and compound interest lies in how the interest is calculated and applied over time. Simple interest is calculated only on the original principal amount of a loan or investment. It grows linearly and produces a fixed amount of interest over each period, based solely on the initial amount. It is commonly used for short-term loans or investments, where the interest does not accumulate on interest earned previously. The formula is I=P×R×TI=P\times R\times TI=P×R×T, where III is interest, PPP is principal, RRR is the interest rate, and TTT is time.
Compound interest, however, is calculated on both the original principal and the accumulated interest from previous periods. This results in exponential growth since interest is earned on interest. It is typically used in long-term investments like savings accounts and retirement funds. The formula is A=P(1+rn)ntA=P(1+\frac{r}{n})^{nt}A=P(1+nr)nt, where AAA is the amount, PPP is principal, rrr is rate, nnn is compounding frequency per year, and ttt is time.
Key Differences
Aspect| Simple Interest| Compound Interest
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Calculation Basis| Principal amount only| Principal + accumulated interest
Growth Pattern| Linear growth| Exponential growth
Typical Use| Short-term loans, car loans, personal loans| Savings accounts,
credit cards, long-term investments
Interest Effect| Fixed over time| Increasing interest over time
Financial Impact| Less total interest earned or paid| More interest earned on
investments or charged on loans
Compound interest allows investments to grow faster over time but can also increase loan costs if not managed well. Simple interest is easier to calculate and more predictable for borrowers.
This summary should clarify the distinction between simple and compound interest fully.