Whether you have debt, money in a savings account, or want to invest, you may run into the concept of compound interest. Also known as compounding interest, it’s interest that earns (or costs) you money on other interest.

Here’s how compounding works: When you earn interest on savings or accumulate interest on debt, that interest is added to the principal amount, increasing the amount of interest that accrues moving forward. When it comes to savings and investments, compound interest works in your favor. However, in terms of debt, it increases the amount of money you owe.

Thanks to compound interest, even if you don’t add additional funds to your savings account, your savings still have the opportunity to grow. For debt, compounding means that the amount of debt you have grows faster than if your account used a simple interest formula.

Simple interest does not compound. Instead, you continue to earn or be charged interest only on the principal amount of money you have either invested or borrowed.

For example, if you invest $100 and earn 5.00% simple interest a year, you will earn $5 that year. Going forward, if you didn’t increase your principal balance with additional contributions, you would continue to only earn $5 per year.

If, however, you earn compound interest on $100 in savings, the first year you would earn $5, which would lead to a new principal balance of $105. The following year, you would earn $5.25 in interest — because the 5.00% interest rate would apply to the new $105 balance. 

Here’s the same example’s year-end balances, for comparison.

If you’re not sure how much compound interest you stand to accrue on debt, an investment, or a savings product, then you can do a simple calculation to figure it out.

To calculate compound interest, you would use the following formula:

P(1 + r/n)^nt=A

P = principal, r = interest rate, n = compounding frequency, t = time, A = final amount, 

For example: 

If you have a loan with a principal amount of $10,000, a 3.00% interest rate, and it compounds once per month for a one-year loan term, you would end up with:

$10,000(1 + .03%/12)^12×1=$10,394.16

To avoid the formula, you can also use a free online compound interest calculator, such as Investor.gov’s.

While compound interest is great when you’re investing or saving money, it can hurt you when it comes to debt. This is because it can make your debt grow, increasing the cost of repayment. When you’re charged compound interest on a form of high-interest debt — like credit card debt — it can even cause your debt to spiral out of control. 

If you have multiple sources of debt with compound interest, it can be beneficial to borrow a debt consolidation loan with a simple interest rate. That way, you can focus on making one debt payment each month and can enjoy a fixed payment that won’t change due to compound interest. 

Let’s look at how interest can work on a personal loan with simple interest versus a credit card with compound interest, each over a one-year repayment term. 

Because of compound interest’s snowballing effect, it’s important to pay off your balance in full each month. At the very least, making extra debt payments (as possible) decreases the balance and the amount of compound interest that can accrue. 

Related: Learn more about getting a personal loan on Credible.com

You want your money to work hard for you, and compound interest is a great way to do that. Even when you can’t contribute more money to your savings, compounding allows your money to grow faster.

Because compound interest works in your favor when it comes to savings accounts, you will want to choose a savings account with the highest possible APY (annual percentage yield). That way, your money can earn as much interest as possible. 

Pay attention to how often interest compounds — the more often it compounds, the more money you stand to earn. Online banks typically offer the best APYs on high-yield savings accounts.