Some types of interest rates cost you money and some earn you money. Some compound interest and others don’t — and then there’s also fixed vs. variable rates to consider. Knowing the terminology before you choose a new card, loan or account can help you make the best decision.
Knowing the meanings of the most common terms you’ll come across when making financial decisions can help you make the most of your money:
APR. This is the bad kind of interest. APR stand for annual percentage rate, and it’s the amount of interest you have to pay each year. To save the most money, look for loans and credit cards with a low APR.
APY. This is the good kind of interest. APY stands for annual percentage yield, and it’s the amount of interest that gets paid to you each year. To earn the most money, look for savings accounts and investments with a high APY.
What are the different types of interest rates?
There are 2 main types of interest rates — fixed and variable. They can apply to either APR or APY interest rates.
Fixed interest rates. This is a set interest rate that is essentially “locked” for the duration of your loan term. The rate you agree to in your loan contract is guaranteed to remain in place until you close the loan at the end of the term.
Variable interest rates. This is a rate that may change during your loan term and may be more common in some products than others. For example, personal loans can come with variable interest rates, but it’s unlikely for the rate to change during the loan term. On the other hand, it’s much more likely that a mortgage with a variable rate will change.
How is interest charged on different financial products?
Interest works differently depending on the type of product you have:
Credit cards come with variable, annual interest rates. The rates vary depending on what features the card offers, but the average card falls somewhere between 15% and 22% APR. If you have excellent credit, you can qualify for a lower rate. If you have a low credit score, expect to pay on the higher end of that spectrum — or more.
There are 2 types of interest rates on a credit card: purchase rate and cash advance rate. The purchase rate is what you’re charged to make purchases on the card and the cash advance rate is what you’re charged to withdraw cash using the credit card. Credit cards can also offer special interest rates such as introductory 0% rates or balance transfer rates.
Interest rates on personal loans can be fixed or variable and are annual rates. In the past, these rates reflected the market at the time. However, lenders have been moving towards personalizing interest rates based on how risky it is to offer the loan.
This is why there are now 2 types of interest rates you’ll see advertised for personal loans: set rates and risk-based rates. Set rates will be given to everyone who is approved for a personal loan by that lender. Lenders offering risk-based interest rates will do so using a range — 7% to 18% APR, for example — and your exact rate will depend on your credit score and job stability. You can typically get a rate estimate before applying for a loan.
Mortgage interest rates can also be fixed or variable. Fixed interest rates are guaranteed not to change, whereas variable rates may fluctuate. Variable interest rates can change quite frequently, as they’re heavily influenced by the economy.
The interest you’re charged will generally be calculated daily. Mortgages can either be principal and interest — meaning you’re repaying both the interest you’re being charged and the original amount you borrowed — or interest-only. With the latter, you’re only repaying the interest accruing on your debt.
Savings accounts work differently from credit accounts because the interest rates earn you money rather than cost you money. All savings accounts come with a variable base rate, with most calculated daily on your principal balance and paid into your account monthly. This is referred to as compound interest: the interest payments you earn then go on to earn their own interest. Guaranteed Investment Certificates (GICs) and other savings options work similarly, though GICs offer fixed interest rates.
Keep the following in mind when comparing interest rates:
The actual rate. Look at how competitive the interest rate is when comparing. While the cheapest isn’t necessarily the best, a better interest rate can do a lot to save you money in the long run.
Fees. Check for any fees that the account or loan has, including upfront and ongoing fees. If you find an option with a competitive interest rate but sky-high fees, calculate whether it’s still the best option.
Apples-to-apples. While comparing interest rates across products is a good idea, make sure the products you’re comparing are similar. For example, you might compare one credit card to another one with a much lower interest rate, but no added benefits or features.
Yes. Borrowers with excellent credit scores are typically eligible for the most competitive interest rates. Some lenders won’t even consider applicants whose scores fall below a certain threshold. Check your credit score before applying for a new credit card or loan.
Elizabeth Barry is Finder's global fintech editor. She has written about finance for over six years and has been featured in a range of publications and media including Seven News, the ABC, Mamamia, Dynamic Business and Financy. Elizabeth has a Bachelor of Communications and a Master of Creative Writing from the University of Technology Sydney. In 2017, she received the Highly Commended award for Best New Journalist at the IT Journalism Awards. Elizabeth's passion is writing about innovations in financial services (which has surprised her more than anyone else).
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