What is compound interest?

The short answer

Compound interest is when you earn interest not just on your original money, but also on the interest that has already been added — so your money grows faster over time.

How it works

Say you put $1,000 in a savings account that earns 5% per year:

• Year 1 — you earn $50 in interest, bringing your total to $1,050
• Year 2 — you earn 5% on $1,050 (not just the original $1,000), so you get $52.50
• Year 3 — you earn 5% on $1,102.50, and so on

Each year, the amount of interest you earn gets a little bigger because your balance keeps growing. This snowball effect is compound interest.

Simple interest vs. compound interest

• Simple interest — you only earn interest on the original amount. $1,000 at 5% always earns $50 per year.
• Compound interest — you earn interest on the growing total. The longer you leave it, the faster it grows.

Why it matters

Compound interest works for you when you’re saving or investing. The earlier you start, the more time your money has to grow.

But it also works against you when you owe money. Credit cards, loans, and other debt can use compound interest too — meaning your balance can grow quickly if you only make minimum payments.

Key things that affect it

• Interest rate — a higher rate means faster growth
• How often it compounds — daily compounding grows faster than yearly compounding
• Time — the longer your money compounds, the bigger the effect
• Additional contributions — adding money regularly accelerates growth significantly

How to make it work for you

• Start saving early — even small amounts benefit enormously from extra years of compounding
• Leave your money invested — withdrawing resets the snowball effect
• Pay off high-interest debt quickly — compound interest on debt works against you
• Look for accounts that compound daily — they grow slightly faster than those that compound monthly or yearly