What is compound interest?
The amount you earn will depend on the interest rate, how often it is paid, how long you leave your money saved and whether you make withdrawals. This guide explains compound interest with simple examples, and outlines how compounding can apply to investments and borrowing.
How does compound interest work?
You can earn interest on your savings, and compound interest is a type of interest used by most banks. Compound interest works differently to standard interest, in that you earn interest on your original deposit plus any accumulated interest.
For example, if you were to put £1,000 in your savings account at an annual interest rate of 1.5% AER / gross, you’d earn £15.10 (1.5% AER / gross of £1,000) of interest in the first full year.
In the second year, you’d earn interest on that new, higher balance, not just your original £1,000. So, you’d earn £15.33 (1.5% AER/Gross of £1,015.10) giving you £1030.44.
| Year | Opening balance | Yearly interest of 1.5% AER / gross | Closing balance |
|---|---|---|---|
| 1 | £1,000.00 | £15.10 | £1,015.10 |
| 2 | £1,015.10 | £15.33 | £1,030.44 |
| 3 | £1,030.44 | £15.56 | £1,046.00 |
| 4 | £1,046.00 | £15.80 | £1,061.80 |
| 5 | £1,061.80 | £16.04 | £1,077.83 |
| 10 | £1,144.44 | £17.29 | £1,161.73 |
| Year | 1 | 1 |
|---|---|---|
| Opening balance | £1,000.00 | £1,000.00 |
| Yearly interest of 1.5% AER / gross | £15.10 | £15.10 |
| Closing balance | £1,015.10 | £1,015.10 |
| Year | 2 | 2 |
| Opening balance | £1,015.10 | £1,015.10 |
| Yearly interest of 1.5% AER / gross | £15.33 | £15.33 |
| Closing balance | £1,030.44 | £1,030.44 |
| Year | 3 | 3 |
| Opening balance | £1,030.44 | £1,030.44 |
| Yearly interest of 1.5% AER / gross | £15.56 | £15.56 |
| Closing balance | £1,046.00 | £1,046.00 |
| Year | 4 | 4 |
| Opening balance | £1,046.00 | £1,046.00 |
| Yearly interest of 1.5% AER / gross | £15.80 | £15.80 |
| Closing balance | £1,061.80 | £1,061.80 |
| Year | 5 | 5 |
| Opening balance | £1,061.80 | £1,061.80 |
| Yearly interest of 1.5% AER / gross | £16.04 | £16.04 |
| Closing balance | £1,077.83 | £1,077.83 |
| Year | 10 | 10 |
| Opening balance | £1,144.44 | £1,144.44 |
| Yearly interest of 1.5% AER / gross | £17.29 | £17.29 |
| Closing balance | £1,161.73 | £1,161.73 |
Explore: ISAs or savings accounts
How monthly deposits can boost your compound interest
The earlier you start saving, the more time you have to earn compound interest. If you can, it’s a good idea to regularly add to your savings account to keep your money growing. For example, if you added £20 a month to that initial £1,000 deposit with an annual interest rate of 1.5% AER / gross, you'd boost your savings even more.
| Year | Opening balance | Total amount added yearly | Yearly interest of 1.5% AER / gross | Closing balance |
|---|---|---|---|---|
| 1 | £1,000.00 | £240 | £17.06 | £1,257.06 |
| 2 | £1,257.06 | £240 | £20.95 | £1,518.01 |
| 3 | £1,518.01 | £240 | £24.89 | £1,782.89 |
| 4 | £1,782.89 | £240 | £28.89 | £2,051.78 |
| 5 | £2,051.78 | £240 | £32.95 | £2,324.73 |
| 10 | £3,458.37 | £240 | £54.19 | £3,752.57 |
| Year | 1 | 1 |
|---|---|---|
| Opening balance | £1,000.00 | £1,000.00 |
| Total amount added yearly | £240 | £240 |
| Yearly interest of 1.5% AER / gross | £17.06 | £17.06 |
| Closing balance | £1,257.06 | £1,257.06 |
| Year | 2 | 2 |
| Opening balance | £1,257.06 | £1,257.06 |
| Total amount added yearly | £240 | £240 |
| Yearly interest of 1.5% AER / gross | £20.95 | £20.95 |
| Closing balance | £1,518.01 | £1,518.01 |
| Year | 3 | 3 |
| Opening balance | £1,518.01 | £1,518.01 |
| Total amount added yearly | £240 | £240 |
| Yearly interest of 1.5% AER / gross | £24.89 | £24.89 |
| Closing balance | £1,782.89 | £1,782.89 |
| Year | 4 | 4 |
| Opening balance | £1,782.89 | £1,782.89 |
| Total amount added yearly | £240 | £240 |
| Yearly interest of 1.5% AER / gross | £28.89 | £28.89 |
| Closing balance | £2,051.78 | £2,051.78 |
| Year | 5 | 5 |
| Opening balance | £2,051.78 | £2,051.78 |
| Total amount added yearly | £240 | £240 |
| Yearly interest of 1.5% AER / gross | £32.95 | £32.95 |
| Closing balance | £2,324.73 | £2,324.73 |
| Year | 10 | 10 |
| Opening balance | £3,458.37 | £3,458.37 |
| Total amount added yearly | £240 | £240 |
| Yearly interest of 1.5% AER / gross | £54.19 | £54.19 |
| Closing balance | £3,752.57 | £3,752.57 |
How compounding works on investments
When thinking about how much your money could earn, remember to also consider the impact of inflation. As time goes by, inflation can reduce the total value of your savings because you’ll be able to buy less with the money.
If you want to find a way to potentially beat inflation, you might want to consider investing. With investing, you don’t earn interest. Instead, you’re aiming to get a return on the money you invest.
When your investment generates a return, you can choose to reinvest it rather than withdraw it. This allows your returns to generate further returns. This is the process of compounding, where returns are earned on your original investment as well as any gains you have already made. Over time, this can help your investment grow, as each new return has the potential to generate further returns.
Keep in mind that with investing there are no guarantees, and there’s a chance you may not get back what you put in.
You should always plan to invest for 5 years or more to give your money more time to potentially recover from any market dips. However, your money’s not locked away – it can be accessed at any time.
For those looking for compound interest investments in the UK, understanding how compounding works can help you make more informed investment decisions.
To see how much your money could be worth in years to come, under different market conditions, try our investment calculator.
Explore: New to investing?
Does compound interest apply to debt?
Yes, compound interest doesn’t just grow your savings, it can also grow what you owe. Some forms of lending may also be subject to compound interest, including some credit cards and loans – meaning you’ll owe interest on the interest you’ve already built up.
This is why debts can grow faster than you expect if they’re left unpaid. Understanding how compounding works can help you stay on top of repayments and reduce the total amount of interest you pay.
Explore: How to repay debts
Definitions
AER stands for annual equivalent rate. This shows how much interest you’ll earn if you keep your savings in the account for a full year. All banks and building societies show their interest rate as AER, which can help make it easier when comparing savings accounts.
Gross is the rate of interest paid before any tax (where applicable) has been deducted. Basic rate taxpayers (20%) have a personal savings allowance of £1,000 – meaning they don’t need to pay tax on any interest earned up to this limit. Higher rate tax payers (40%) can earn £500 in tax-free interest per year. Additional rate taxpayers (45%) have no tax-exempt savings allowance. The value of any tax benefits depends upon your individual circumstances. Tax rules may change in future.
This article provides general information and does not take into account the financial situation of the reader. For this reason, it must not be relied on as financial advice. All accounts are subject to terms and conditions.
This article was last updated:01/10/2026, 03:42
