How to Calculate Interest on a Loan: Simple vs Compound

Simple interest: Principal × Rate × Time. A $10,000 loan at 5% for 3 years: $10,000 × 0.05 × 3 = $1,500 interest. Total repayment: $11,500. Simple and predictable. But most loans use compound interest, where interest is charged on the principal PLUS previously accumulated interest.

Compound Interest on Debt

Credit cards compound daily. A $5,000 balance at 24% APR does not cost $1,200/year in interest (5,000 × 0.24). The daily rate is 0.0657% (24% / 365). On day one: $5,000 × 0.000657 = $3.29. On day two: $5,003.29 × 0.000657 = $3.29. It compounds — interest earns interest. Over a year with no payments: $5,000 becomes $6,356, not $6,200. The difference grows dramatically with higher balances and longer time periods.

Using Compound Interest in Your Favor

The same force that makes debt expensive makes savings powerful. $10,000 at 10% compounded annually: $10,000 year 0, $11,000 year 1, $12,100 year 2, $13,310 year 3. You earn interest on interest. After 30 years: $174,494 from a single $10,000 investment with no additional contributions.