Interest that earns interest. It sounds simple, but the math is quietly reshaping your finances every month — sometimes in your favour, usually in the bank’s.
The basic idea
With simple interest, you earn (or pay) a fixed percentage of your original amount each year. Borrow $10,000 at 7% for 20 years and you owe $14,000 in interest — tidy math.
Compound interest changes one thing: the interest itself earns interest. At the end of year one you owe $10,700. In year two, the 7% applies to $10,700 — not the original $10,000. That extra $49 feels trivial. Multiply it across decades and it becomes transformative.
The formula:
A = P (1 + r/n)^(nt)
- A = final amount
- P = principal
- r = annual rate
- n = compounding periods/year
- t = time in years
See it for yourself
So what about your mortgage?
Here’s where compound interest works against you. A mortgage uses the same exponential math — but instead of growing your wealth, it grows the bank’s revenue from your loan.
In Canada specifically, mortgages compound semi-annually by law (twice a year), even though you make monthly payments. This is actually slightly more favourable than US mortgages, which typically compound monthly.
The real sting is amortization. Because interest is calculated on your outstanding balance, the bulk of your early payments goes almost entirely to interest. On a $500,000 mortgage at 5% over 25 years:
- Month 1: ~$2,083 to interest, ~$825 to principal
- Month 150 (year 12.5): roughly 50/50 split
- Final months: almost entirely principal
Total interest paid over those 25 years: roughly $372,000. You’d pay back nearly $872,000 on a $500k loan.
Is the system rigged?
It’s a fair question. Banks profit enormously from interest, and that money comes from ordinary borrowers. The structure tends to concentrate wealth upward — people with less capital pay more (higher rates, more fees) to access the same financial tools that wealthy people get cheaply.
That said, the full picture is more nuanced. Borrowers consent to the terms. Banks take on real risk when lending. Competition between lenders does exert some downward pressure on rates. And alternatives like credit unions — which are member-owned and return profits to borrowers — exist and are worth considering.
The more precise critique is about structural inequality rather than malice: a system where having money makes it easier to get more of it, and not having money costs you extra. Understanding compound interest is the first step to navigating it on your own terms.
Three things you can do today
- Make extra mortgage payments early. Every dollar paid against principal in year 1 saves you years of compounding interest down the line.
- Use compound interest for you. A TFSA or RRSP invested consistently benefits from the same exponential curve — just in your favour.
- Compare credit unions. Member-owned institutions often offer better rates because they’re not optimising for shareholder profit.