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How does compound interest work in Canada, and which terms should you know?

By FastBuySale Newsroom · 9 Nov 2026 · 1m ago

Key terms: principal, simple interest and compound interest

Principal: the FCAC says the money you deposit into a savings account is called the principal. GetSmarterAboutMoney.ca explains that both simple and compound interest are based on the amount you start with, and that interest is calculated as a percentage of the principal amount.

Simple interest: this is calculated on the principal amount only. GetSmarterAboutMoney.ca gives this example: if you start with $100 and earn 5% simple interest annually, you will have $105 at the end of the first year, $110 at the end of the second year and $115 after the third year. Each year, 5% of the original amount is added, and nothing more.

Compound interest: this is calculated on the principal and any interest you have already earned. Using the same $100 at 5% compounded each year, GetSmarterAboutMoney.ca shows a balance of $105 after the first year, $110.25 at the end of the second year and $115.76 after three years. Compound interest reinvests the interest each year, so it earns a little more money.

Interest on interest: the FCAC lists the four steps of compounding. You earn interest on your principal; your bank adds the interest you earn to your savings account; you earn interest on the new total balance; and you keep earning interest on your total savings.

Why the gap grows: in the 5% example the difference after three years is only 76 cents. GetSmarterAboutMoney.ca notes that this might not seem like a lot, but as you continue to add to your savings over time, compound interest can really add up. You can test longer periods with the https://fastbuysale.com/tools/compound-interest-calculator/ on FastBuySale.

How often does interest compound, and why does it matter?

Annual rate vs compounding: the FCAC says financial institutions usually advertise an annual interest rate, and some savings accounts may compound interest monthly or daily. It also says financial institutions usually calculate interest daily and deposit it into your account monthly.

Frequency matters: according to the FCAC, you may earn more interest if your financial institution compounds interest daily rather than monthly. Its advice is to contact your financial institution to learn how often it compounds the interest paid to your account.

Other frequencies: GetSmarterAboutMoney.ca adds that, depending on the account, compound interest could be calculated weekly, monthly or annually. So two accounts that advertise the same annual rate can pay slightly different amounts in practice.

Days in the month: the FCAC notes that the interest formula may also depend on the number of days in the month, and your financial institution may pay a little more interest during longer months.

The FCAC monthly example: suppose you deposit $100 each month into a savings account with an annual interest rate of 2%, compounded monthly. Each month you earn about 0.167% (2% divided by 12 months) on your balance. After 1 month you have $100 and earn $0.17. In the second month, interest is calculated on the $200 you have deposited plus the $0.17 already earned, so on $200.17 you earn $0.33. By the end of the first year you earn about $13.08 in interest.

Over five years: the FCAC's table shows interest of $13.08 after year 1 (balance $1,213.08), $50.64 after year 2 ($2,450.64), $113.18 after year 3 ($3,713.19), $201.20 after year 4 ($5,001.20) and $315.22 after year 5, on $6,000 of deposits, for a balance of about $6,315.24. The FCAC says this example uses rough figures, and the longer you continue to save and earn compound interest, the faster your savings grow.

Rules to check in your account agreement

Tiered rates: the FCAC says some financial institutions apply 2 or more interest rates to different portions of your balance. Check whether the higher rate is paid on all the money in your account, on all the money only once your balance goes above a certain amount, or only on the part of your balance above a certain amount.

Examples from the FCAC: a financial institution may pay 1% on the first $1,000 of your balance and 2% on amounts above $1,000; pay 2% on the entire balance if you keep at least $1,000 in the account; or not pay interest for a month when you withdraw money from the account.

Minimum balances: some accounts need you to keep a certain amount in the account to earn interest, in some cases at least $1,000. The FCAC suggests asking yourself whether you are making the best use of your money by keeping it there.

Introductory rates: financial institutions may offer high-interest introductory rates for a limited time, after which the rate may be lower. Before choosing one, check that you will earn a reasonable rate after the introductory period ends and that you understand the terms and conditions. The FCAC also recommends reviewing your savings account periodically, especially after a promotional rate ends.

Fees eat into compounding: you usually do not pay monthly fees on a savings account, but you may pay for transactions such as withdrawals or transfers, and you may be charged non-sufficient funds (NSF) fees. Read your account agreement to know these fees. For more on keeping a separate savings pot, see https://fastbuysale.com/news/ca/saving-money-in-canada-rules-and-key-terms-to-know and https://fastbuysale.com/news/ca/emergency-funds-in-canada-rules-and-key-terms-to-know.

Compounding in GICs and investments, and how it is taxed

Guaranteed investments: GetSmarterAboutMoney.ca says investments like savings accounts, GICs and bonds pay interest, and that Guaranteed Investment Certificates (GICs) pay a guaranteed rate of return, so you know how much you will earn by the end of a specific period.

GIC example: GetSmarterAboutMoney.ca shows $10,000 invested for three years in a GIC earning 2.5% compounded annually. Interest is $250 in year 1 (value $10,250), $256.25 in year 2 ($10,506.25) and $262.65 in year 3, for an end value of $10,768.90.

Investing returns: for stocks, bonds and other asset classes, GetSmarterAboutMoney.ca explains that compounding means your investments earn a return each year, and if you reinvest these earnings by putting them back into the original investment, you grow your money more quickly. Unlike a GIC, these returns are not guaranteed. A steady monthly approach is covered in https://fastbuysale.com/news/ca/dollar-cost-averaging-in-canada-rules-and-key-terms-to-know.

Time is the biggest lever: according to GetSmarterAboutMoney.ca, the younger you are and the longer your investing time horizon, the more compound interest can work, though it is never too late to get started. To see how long-term saving might add up, try the https://fastbuysale.com/tools/retirement-calculator/, and use the https://fastbuysale.com/tools/inflation-calculator/ to compare growth with rising prices.

Tax on interest: the FCAC says you usually need to pay income tax on the interest you earn in a savings account. Each year your financial institution sends a Statement of investment income (T5), which shows how much investment income you earned, including interest from bank accounts, and you must report this income on your personal tax return.

TFSA option: the FCAC says that if your goal is long-term savings, a TFSA may help, because you do not pay tax on the interest you earn or the money you withdraw from a TFSA. Learn more in https://fastbuysale.com/news/ca/tfsas-rules-explained-in-plain-english.

Quick recap of terms: principal (your deposits), simple interest (on principal only), compound interest (on principal plus earned interest), compounding frequency (daily, weekly, monthly or annually), annual interest rate (the advertised yearly rate), tiered rate (different rates for different portions of the balance), introductory rate (a temporary higher rate), GIC (a guaranteed rate for a set term) and T5 (the slip reporting your interest income).

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