Compound interest means interest is added to a balance, and later interest can be calculated on that updated balance. The effect depends on the starting amount, rate, time, and how often interest is compounded.
A Simple Example
Suppose 1,000 earns 5% per year and compounds once each year, with no deposits or withdrawals. After the first year, the balance is 1,050. In the second year, 5% is calculated on 1,050, so the balance becomes 1,102.50. The additional $2.50 is interest earned on the first year's interest.
For a fixed annual rate compounded a set number of times each year, the standard model is: final balance = principal × (1 + annual rate ÷ number of periods) raised to (number of periods × years). This assumes the rate and schedule stay unchanged.
Frequency and Time
More frequent compounding can produce a slightly higher balance under the same nominal rate and time period. Adding regular contributions changes the result too, so check whether a calculator treats deposits as happening at the start or end of each period.
Try different assumptions in the Compound Interest Calculator. For borrowing, compare the estimate with the lender's disclosed APR, fees, and payment schedule; loan APR and an investment's stated return are not interchangeable measures.
Simple Interest Is Different
Simple interest is calculated only on the original principal. Compound interest can include previously credited interest. Actual accounts and loans may include fees, changing rates, taxes, or rules that are not represented by a basic formula.