Simple Interest

Simple interest is calculated only on the original principal. Interest earned does not itself earn interest, so the amount you receive each year stays exactly the same.

Set next to compound interest, the difference is stark. Put $10,000 at 5%: simple interest adds precisely $500 a year, giving $15,000 after 10 years and $20,000 after 20. Compounding gives about $16,290 after 10 years and about $26,530 after 20. At five years the gap is barely noticeable; by twenty it exceeds $6,500. Compounding shows its power only over long horizons.

That is why simple interest turns up in short-dated products, such as deposits maturing within a year or the coupon math on bonds. Over short periods there is no time for interest to earn interest, so the two methods barely differ.

From the borrower's side, simple interest is the friendlier term, since at the same rate the total repaid is smaller than under compounding. So when comparing products, look past the headline rate to whether it is simple or compound, and if compound, how often it is calculated: monthly, quarterly, or annually.