Compound interest is when interest is added to your savings and starts earning interest too. This can help your money grow faster over time.
This can help when you're saving for goals such as a house deposit, retirement or a rainy day or emergency fund.
Compound interest can also apply to borrowing. If unpaid interest is added to a debt, the amount you owe can grow faster.
In this guide
When interest stays in your savings account, it becomes part of your balance and can earn interest too. This means your money can grow faster over time.
For example, let’s say you put £1,000 into an account paying 5% interest. After one year, you'd have £1,050. In the second year, you earn interest on the full £1,050, not just the original £1,000. That means you'd earn £52.50 in interest.
The difference may seem small at first. But over time, those extra interest payments can add up.
Let’s take another look at that example using £1,000 at 5% interest, compounded once a year:
| Year | Balance at the start | Interest earned | Balance at the end |
|---|---|---|---|
| 1 | £1,000.00 | £50.00 | £1,050.00 |
| 2 | £1,050.00 | £52.50 | £1,102.50 |
| 3 | £1,102.50 | £55.13 | £1,157.63 |
| 4 | £1,157.63 | £57.88 | £1,215.51 |
| 5 | £1,215.51 | £60.78 | £1,276.28 |
After five years, your £1,000 has grown to £1,276.28.
That means you’ve earned £276.28 in interest, without paying in any more money.
Please note: These figures are for illustration only. Actual returns will depend on the interest rate and terms of your account.
The difference between simple and compound interest is how interest is calculated.
This is why compound interest can help your savings grow faster over time.
Let’s use the same example of £1,000 at 5% for five years:
| Type of interest | How it works | Balance after five years |
|---|---|---|
| Simple interest | You earn £50 each year on the original £1,000 | £1,250.00 |
| Compound interest | Your interest is added, then earns more interest | £1,276.28 |
The difference here is £26.28.
That may not sound like much. But the difference can grow over time, especially if you save regularly.
The quickest way to work out compound interest is with a savings calculator.
You can also use the Bank of England savings calculator.
Simply enter your savings, monthly payments, time period and interest rate to see how your money could grow over time.
Interest can be added to your savings at different times, such as daily, monthly, quarterly or yearly. How often this happens depends on the savings account you choose.
The more often interest is added, the sooner it can start earning interest itself. This can help your savings grow slightly faster.
Let's look at £1,000 saved at 5% interest for five years:
| How interest compounds | Balance after five years |
|---|---|
| Once a year | £1,276.28 |
| Once a month | £1,283.36 |
The monthly example gives a slightly higher balance because interest is added more often.
The difference may be small over a few years, but it can become bigger if you save more money, earn a higher interest rate or leave your savings untouched for longer.
When comparing savings accounts, don't just look at the interest rate. It's also important to check how often interest is added, account fees and any rules about accessing your money.
AER stands for Annual Equivalent Rate. It's the rate you'll usually see advertised on savings accounts.
AER shows how much your savings could grow in a year, including the effect of compound interest. This makes it easier to compare savings accounts, even if they pay interest at different times.
For example, one account might add interest monthly, while another adds it yearly. AER puts them on the same scale, so you can make a fair comparison.
When comparing savings accounts, AER is one of the first things to look at. In general, a higher AER means your savings could earn more interest over a year. But it's also worth checking things like access rules, fees and whether the rate is fixed or variable.
Compound interest is most common with savings accounts. If interest is paid into the same account, it can start earning interest too.
Cash ISAs work in a similar way. If interest is added to your ISA, it can earn interest over time. Interest earned in a cash ISA is usually tax-free, subject to ISA rules.
The same idea can apply to investments. If any returns are reinvested, they can generate more returns over time.
But savings and investments aren’t the same thing. The value of investments can go up or down, so you could get back less than you put in.
Savings accounts and cash ISAs are generally lower risk. Investments offer the potential for higher returns but come with more risk.
The right option depends on what you're saving for and how much risk you're willing to take.
Read more: What are ISAs and how do they work?
Compound interest isn’t always helpful.
When you're saving, compound interest can help your money grow. When you're borrowing, it can make your debt grow too.
This happens when unpaid interest is added to your debt and starts earning interest too.
For example, if you don’t repay interest on a loan, credit card or other borrowing, the unpaid interest may increase the balance. That can make the debt harder to clear.
Not all borrowing works in the same way. Always check how interest is charged before you borrow.
You may be able to earn some savings interest without paying tax on it.
Under current GOV.UK guidance, the Personal Savings Allowance is:
Savings in tax-free accounts, such as ISAs, do not count towards your Personal Savings Allowance.
You can check the latest rules on tax on savings interest.
Many UK savings accounts are protected by the Financial Services Compensation Scheme (FSCS).
FSCS says eligible deposits can be protected up to £120,000 per eligible person, per authorised institution.
You can check what's covered on the FSCS protection page.
Compound interest is useful to understand. But it’s only one part of choosing a savings account.
Before you open one, check:
A higher rate can look appealing. But make sure the account fits how you plan to use your money.
You can’t control every part of saving. Rates can change and life can get expensive.
But there are simple steps that may help compounding do more for you:
And remember, small habits can make a difference over time.
Interest is added to your savings. The next time interest is calculated, you earn interest on both your savings and the interest already added. This can help your money grow over time, especially if you keep adding to your savings.
Yes. A separate account keeps your Christmas money safe, visible and easier to manage.
A compound interest savings account is a savings account where interest is added to your balance. The next time interest is calculated, you earn interest on both your savings and the interest already added.
A separate travel fund can help. Booking early and using a prepaid travel card can also make costs easier to manage.
Compound interest can be helpful when you're saving because it can help your money grow over time. But if you're borrowing money, it can also make your debt grow faster.
Yes. Savings apps with pots and round ups can make saving automatic.
As early as you can. Starting in January means smaller monthly amounts over the year compared with leaving it until later to start saving or budgeting.
Yes. If interest is added to your cash ISA and left in the account, it can earn interest too. Interest earned in a cash ISA is usually tax-free, subject to ISA rules.
You might. Whether you pay tax depends on how much interest you earn and your personal tax situation. Check the latest GOV.UK guidance for current rules.
Keep your money somewhere safe and withdraw when you need to. Earn a variable rate on what you save
Lock money away for a set term and know what interest rate you’ll earn during that time
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