Whether you’re saving for the future or borrowing money for a major purchase, understanding the core difference between compound and simple interest will help you manage your finances effectively. These two types of interest can affect your total amount saved—or the total amount you’ll have to repay—depending on how they’re calculated.
In this article, we’ll explore how interest works, how to calculate it, and how it can affect your personal finances here in Canada.
What is interest?
Interest is the cost you pay for borrowing money, or the reward (or return) you gain for saving or investing money. When you borrow money, you pay interest to the lender. When you save or invest, you earn interest from the bank or investment. The interest rate is usually expressed as a percentage, and there are two types of interest that you should be aware of.
- Simple interest calculates interest only on the principal amount (the original sum).
- Compound interest calculates interest on both the principal and the interest accrued from previous periods.
No one wants to pay more than necessary on a bill or loan. Nor lose out on potential savings or investment growth. Awareness of these differences can help make sure neither of those situations happens to you.
Simple interest
Formula
If you’ve wondered how to calculate simple interest, here is the formula.
Interest = Principal × Rate × Time
- Principal represents the original amount borrowed or invested
- Rate represents the annual interest rate, written as a decimal
- Time is the loan term or investment period in years
Let’s take a simple example. You borrow $2,000 at a 6% simple interest rate for 3 years:
Interest = $2,000 × 0.06 × 3 = $360 Total amount payable = $2,360
Of course, simple interest is much easier to understand and calculate. You can use a simple interest calculator to test out different loan terms and amounts and understand the impact on how much you will owe.
Application
Simple interest is most often used for:
- Short-term loans
- Car loans
- Some personal or term loans
Borrowing over a shorter period is often more affordable since the interest doesn’t compound over time.
Compound interest
Compound interest means you earn or pay interest not only on your principal balance, but also on any interest accrued during previous periods. Over time, this makes your money grow—or your debt increase—faster. Put another way, the first interest calculation is only on the amount you borrowed (or invested), but the second payment onward calculates the interest based on the combined interest earned/accrued, plus the principal. Most Canadian banks compound interest daily or monthly, making it crucial to understand how these calculations work.
Formula
Interest = Principal × (1 + Rate ÷ n) ^ (n × Time)
- Principal represents the original amount borrowed or invested
- Rate represents the annual interest rate, written as a decimal
- n is the number of compounding periods per year (monthly, quarterly, etc.)
- Time is the number of years
- ^ represents an exponent
Let’s say you invest $5,000 at a 5% compound interest rate, compounded monthly for 4 years:
Principal: $5000
n = 12 (Months)
T = 4 (years)
Rate = 0.05 (for 5%)
Amount = $5000 × (1 + .05/12) ^ (12 × 4)
Your investment would grow to about $6,104.48. That’s $1,104.48 in interest accrued.
Compound interest calculations seem complex. The good news is, you don’t have to be great at math to calculate compound interest; free online calculators can help you.
Applications
Compound interest is commonly used for:
- High-interest savings accounts
- Credit cards
- Mortgages
- Investment loans
Simple vs. compound interest: Key differences
| Feature | Simple Interest | Compound Interest |
| Based on | Principal only | Principal + interest |
| Grows | Slower | Faster |
| Easier to calculate | Yes | More complex |
| Common uses | Term loans, car loans, GICs | Credit cards, mortgages, investments |
| Total cost/return | Lower | Higher over time |
In general, simple vs compound interest comes down to how much time and compounding are involved. The longer the period, the more compound interest can grow—either in your favour (savings) or against you (debt).
How interest impacts Canadians
Borrowing money: Look at the bigger picture
Consumer debt in Canada reached a new record of $2.5 trillion in outstanding debt as of 2025. Odds are you are one of the “32.3 million Canadians holding at least one open credit product”. So, if you’re planning to borrow money, it’s so important to understand how interest works. Some lenders may advertise a simple interest rate, but your actual cost will depend on how they calculate payments. You may see the rate referred to as the APR (Annual Percentage Rate), which includes any applicable fees and charges.
Compound interest can significantly increase the interest payable over long loan terms, especially if payments are missed or delayed. Credit card debt can be complicated to pay off, as the interest compounds quickly and rates are typically high.
Before you make any big decisions on borrowing money, read the fine print and try using online calculators to:
- Understand if the loan uses simple or compound interest
- Calculate simple or compound interest
- Understand your principal vs interest breakdown
- Estimate your total amount over the term
Saving and investing: Let interest work for you
If you’re saving, compound interest helps your money grow faster over time. Increasing savings, especially as interest rates and inflation fluctuate, is one way to protect your financial stability. The more frequently your interest compounds—and the more often you contribute—the more you benefit.
Start with:
- A high-interest savings account or investment account
- Automatic contributions to build your principal amount
- A clear understanding of how often interest compounds (per year)
Getting the best out of your interest
When borrowing
- Go for simple interest loans when possible
- Unless you can secure a low interest rate, avoid long loan terms
- Try to pay more than the minimum to reduce interest charges
When saving/investing:
- Look for products with frequent compounding periods
- Reinvest your earnings & dividends to grow your principal
- Use a calculator to set financial goals and compare options
Understanding how to calculate interest is a valuable skill that every Canadian should learn. It can help you make wise decisions with your money.
The takeaway: Mastering interest helps you take control
Making interest work for you can make a huge difference to your financial future. It’s not simply a detail to gloss over. No matter if you are saving for a goal or borrowing to cover a cost, knowing the difference between simple interest and compound interest helps you plan smarter and avoid surprises. Review the interest rate, principal balance, period, and total interest payable before signing on the dotted line to make the best choice for your money.
