What Is Compound Interest and How Does It Work?
Updated August 2026
Learn what compound interest means, how it grows money over time, how compounding frequency matters and how to calculate it with a simple example.
What is compound interest?
Compound interest is interest calculated on your starting balance and on interest that has already been added. This is often described as earning interest on your interest. It is one of the main reasons savings and investments can grow faster over long periods.
For example, £1,000 earning 5% a year becomes £1,050 after one year. If the interest is compounded annually, the next 5% is calculated on £1,050 rather than the original £1,000. After the second year the balance is £1,102.50.
Want to try the idea yourself? Use the Compound Interest Calculator.
Why compounding makes such a difference
At first, the extra growth from compounding may look small. Over many years, however, each new interest payment increases the balance used for the next calculation. Time therefore has a major effect on the final amount.
The interest rate matters too. A higher rate increases the amount added each period, while regular deposits can give compounding a larger balance to work on.
If you want to explore this topic further, see How to Calculate Compound Interest.
How often can interest be compounded?
Interest may be compounded yearly, monthly, daily or at another interval. More frequent compounding can produce a slightly higher final balance when the quoted annual rate is the same, because interest is added to the balance sooner.
Always check how a savings account, investment or debt actually applies interest. The advertised rate and the compounding frequency are separate details.
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Compound interest formula
A common formula is A = P(1 + r/n)^(nt). P is the starting amount, r is the annual interest rate as a decimal, n is the number of compounding periods per year, t is the number of years and A is the final amount.
You do not need to calculate this by hand. The Compound Interest Calculator lets you enter the starting amount, rate and time period and compare how the balance changes.
Compound interest on savings and debt
Compounding can work in your favour when money is earning interest, but the same principle can make borrowing more expensive when unpaid interest is added to a debt. The important question is whether interest is increasing money you own or money you owe.
When comparing scenarios, look at the rate, time period, compounding frequency and any regular contributions or repayments rather than focusing on one figure alone.
Try it yourself
Ready to put this into practice? Open the relevant Wid9et tools directly in your browser.