Simple interest is calculated only on the original principal amount over the entire period, meaning the interest amount remains constant every period. Compound interest, however, is calculated on the principal plus any accumulated interest from previous periods, so the interest grows exponentially over time. Key differences include:
- Simple interest uses the formula Simple Interest=Principal×Rate×Time\text{Simple Interest}=\text{Principal}\times \text{Rate}\times \text{Time}Simple Interest=Principal×Rate×Time, and it provides steady, predictable interest payments.
- Compound interest uses the formula Compound Interest=P(1+rn)nt−P\text{Compound Interest}=P\left(1+\frac{r}{n}\right)^{nt}-PCompound Interest=P(1+nr)nt−P, where interest is calculated on both the principal and accumulated interest, resulting in higher returns over time especially for investments.
- Simple interest is generally more beneficial for borrowers as it keeps interest payments lower and stable.
- Compound interest benefits savers and investors by growing investments faster through interest on interest.
In summary, simple interest grows linearly, while compound interest grows exponentially, making compound interest more advantageous for long-term investments but potentially more costly for long-term loans.