Compound vs Simple
Interest Compared

Simple interest is the most basic way to calculate interest. You earn (or pay) a fixed percentage of your original deposit every year — and that amount never changes, regardless of how much interest has already been added.

The formula is straightforward: Interest = P x r x t, where P is the principal (original amount), r is the annual rate, and t is the time in years.

For example, if you deposit £10,000 at 5% simple interest, you earn exactly £500 every year. After 10 years you have £15,000. After 20 years you have £20,000. The growth is linear — it follows a straight line and never accelerates.

Compound interest calculates interest on both your original deposit and all the interest that has previously been added. Each time interest is calculated, the base amount is larger — which means the next interest payment is larger too.

The formula is: A = P(1 + r/n)^nt, where n is how many times per year interest compounds. (See our full compound interest formula guide for a detailed breakdown.)

Using the same £10,000 at 5% compounded annually: after year one you have £10,500 (same as simple). But in year two, you earn 5% on £10,500 — that is £525, not £500. In year three, you earn 5% on £11,025 — that is £551.25. The interest grows every single year, creating an upward curve rather than a straight line.

Look at the table above and notice what happens over time. After just 1 year, there is no difference at all — both produce £10,500. After 10 years, compound interest has earned you an extra £1,289. Noticeable, but not life-changing.

But after 30 years, the gap explodes. Simple interest gives you £25,000 total. Compound interest gives you £43,219 — that is £18,219 more from the same starting amount and the same interest rate. The compound balance is 73% larger than the simple balance.

This is the core lesson of compounding: time is the multiplier. The first few years barely show a difference. The last few years produce enormous gains. This is why starting to invest early — even with small amounts — is so much more powerful than waiting and investing large amounts later.

Virtually every UK savings account — from high street banks to online-only challengers — uses compound interest. When your bank quotes an AER (Annual Equivalent Rate), that figure already includes the effect of compounding. An AER of 4.5% means you will earn 4.5% over a full year once compounding is factored in, regardless of whether the bank compounds daily, monthly, or quarterly.

This is good news for savers. It means the interest you earn in January starts earning its own interest by February (or sooner, depending on compounding frequency). Over decades, this compounds into meaningfully higher returns than simple interest would deliver.

The same principle applies to investments held in a Stocks & Shares ISA. When your investments grow in value, those gains become part of your total balance. Future growth is calculated on the larger balance. Reinvested dividends further accelerate the compounding effect. And because ISA returns are tax-free, 100% of the compound growth stays in your account.

Some UK personal loans and car finance agreements use simple interest. This means the total interest cost is calculated upfront based on the original loan amount and the full term, then spread across your monthly payments. Even as you pay down the balance, the interest charge does not decrease.

With a simple interest loan, overpaying does not save you as much as it would with a compound interest loan (like a mortgage). The interest has already been fixed. With a compound interest mortgage, by contrast, overpaying reduces the principal, which immediately reduces the interest charged in the next period — a compounding benefit in your favour.

Credit cards, on the other hand, charge compound interest — and at very high rates (typically 20-25% APR). If you carry a balance, the interest compounds monthly, causing the debt to grow rapidly. This is one of the most damaging applications of compound interest and a strong reason to avoid carrying credit card debt.