Interest calculated only on the principal, not on accumulated interest.
Simple interest is interest calculated only on the original principal, not on previously earned interest. The formula is: Interest = Principal × Rate × Time. For example, $1,000 at 5% simple interest for 3 years earns $1,000 × 0.05 × 3 = $150 in interest, for a total of $1,150. Simple interest is straightforward but generates less wealth than compound interest, where interest earns interest. Simple interest is typically used for short-term loans, whereas compound interest is standard for savings accounts, investments, and mortgages. After 10 years at 5% annual rate, simple interest generates $500 in interest; compound interest generates $628—a 26% difference. For most people, understanding compound interest is more important than simple interest because savings, investments, and mortgages all compound.