Interest is the cost of borrowing money or your profit when lending 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.
When you borrow money, interest is calculated as a percentage of the principal balance and added to it, so you end up paying back more money than you borrowed. Each monthly payment you make is split between paying back the principal and one month’s interest.
When you lend money out yourself — or put it in a savings account for the bank to lend out — you earn interest because you let someone else use your funds.
Difference between APY vs. APR
Annual percentage yield (APY) and annual percentage rate (APR) are two common interest rate terms that you’ll come across when making financial decisions from opening a bank account to taking out a loan. Here’s a breakdown of what they are and the key differences between them.
Type of interest
What it is
Where you find it
Common factors that impact interest rate
How to maximize your money
APY
Interest you earn
Savings accounts
Type of savings vehicle, such as a savings bank account or certificate of deposit
Provider
Compounding frequency
To earn the most money, look for savings accounts and investments with a high APY.
APR
Interest you pay
Loans
Credit cards
Type of credit product
Provider
Your credit history
Fees
To save the most money, look for loans and credit cards with a low APR.
Interest rate example
How much you earn or pay in interest can vary significantly. Here are two common APY and APR scenarios:
APY interest
For savings accounts, the interest rate is probably the most important factor in growing the money you’ve stashed away. While many traditional banks and credit unions pay an interest rate somewhere around the national average of 0.06%, there are several others that pay around 2.00% or more.
Let’s say you have a savings account balance of $5,000 that offers the national average 0.06% APY. If you don’t add any money to it and you earn interest every month that is added back to the account, you’d make a profit of $4.50.
On the other hand, if your interest rate was 2%, you’d make $100.92 in one year — a difference of about $95.
APR interest
Whenever you borrow money, the APR tells you how expensive your loan costs. For example, let’s say you’re looking to borrow $200,000 to buy a home. Your lending terms include a 4% interest rate with a loan term of 30 years. Over the course of your mortgage, you’d make 360 monthly payments and pay close to $143,739 in interest.
But if you could snag an APR of 3%, you’d end up paying $103,555 over the course of the loan — a difference of 1% in interest and a savings of over $40,000.
4 types of interest rates
There are several different types of interest rates:
Fixed interest rate. 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 rate. 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. Variable interest rates are regularly adjusted by your bank in line with fluctuations to the federal funds rate. In other words, the maximum variable rate of interest you can earn will go up and down over time.
Compound interest rate. This is calculated based on your current account balance, which includes any interest previously earned. It’s called compound interest because you earn interest on your interest, which makes the sum grow faster. It’s mostly used for bank accounts.
Simple interest rate. This form of interest is only calculated on the principal balance. It doesn’t include any interest you’ve already earned. Simple interest is mostly used for car loans.
How often interest is compounded
The interest on your account could be compounded daily, monthly, quarterly, biannually or annually, and the frequency with which it occurs can make a surprising difference to your balance. The more interest is compounded, the more chances you have to earn interest on your interest.
Case study
Adam is in his early 20s and wants to start saving for a house. He has an initial investment of $5,000 and plans to deposit $500 each month for the next five years. Assuming an interest rate of 5%, let’s look at how Adam’s balance differs based on whether interest is compounded daily, monthly or annually.
Account A
Account B
Account C
Interest compounded
Daily
Monthly
Annually
Initial deposit
$5,000
$5,000
$5,000
Ongoing monthly deposit
$500
$500
$500
Investment term
5 years
5 years
5 years
Interest rate
5%
5%
5%
Total balance
$39,931.81
$39,919.83
$39,788.28
Adam can earn more interest by choosing an account that compounds interest daily. In fact, after five years, he ends up with an extra $143.53 compared to an account that compounds interest annually.
The rate of interest you earn on your savings is set by your bank, though interest rates generally fluctuate with the broader financial market and can be influenced by the rates set by the Federal Reserve Bank. Interest rates vary by bank and the type of savings account you choose.
Savings accounts typically accrue daily or monthly compound interest. With daily compound interest, your bank calculates interest on your balance each day using a specified rate. In effect, you end up earning interest on the interest you’ve already earned. Your bank then pays out the compounded interest monthly as a credit to your account.
Your money doesn’t sit in a savings account untouched. When you open an account, you give your bank access to lend your money out to others.
Banks reward you for that access with interest, even if those rates are slightly lower than the rate they charge borrowers. It’s how they stay in business.
And if the bank loses money on that loan, it doesn’t affect your account balance. Furthermore, the vast majority of banks and credit unions are insured by the government, so even if they go out of business, you’ll get up to $250,000 back.
How to get higher interest rates
To get a bump in your savings account APY:
Compare accounts. Both at different banks and even within the same bank. For example, if you meet the monthly minimum, a money market account could net you a higher interest rate than a traditional savings account. If you won’t need to access your money anytime soon, consider opening a CD account.
Consider online and challenger banks. Newer online-only and app-based challenger banks don’t have to deal with the overhead that comes with operating bank branches, and they can pass those savings on to you in the form of better interest rates.
Look for introductory offers. Some savings and money market accounts will offer increased rates for an introductory period. Just make sure that you’re still happy with the rate your account will revert back to when that period is up.
How much difference does a 0.50% or 1.00% increase in APY make?
A percent, or even half a percent, difference can add up to significant savings over time. For example, Rebecca puts $40,000 into a savings account with a 2.50% APY, and she adds $750 each month. After five years, she’s made $8,200.45 in interest.
If she would have opened an account with a 3.00% APY, she would have made $9.949.71 in interest, or about $1,749 more.
If Rebecca’s APY was 3.50%, she would have made $11,737.30 — that’s an extra $3,537 over five years just for choosing an account with an APY that was 1% higher.
How does interest work on different financial products?
Interest works differently depending on the type of product you have:
Credit cards
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 two 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.
Personal loans
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. Recently, however, lenders have been moving towards personalizing interest rates based on how risky it is to offer the loan.
This is why you’ll now see advertisements for two types of personal loan interest rates: 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.
Home 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. And 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
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. Other savings options like certificates of deposit (CDs) work similarly, though CDs offer fixed interest rates.
Student loans
Student loan interest rates can be fixed or variable, depending on whether you opt for a federal or private loan. To calculate your interest, take your interest rate and divide it by the number of days in the year to get your “interest rate factor.” Then multiply it by your loan balance and the number of days since your last payment.
Each of your student loan payments goes toward the interest first and then reduces your principal. As you make more payments, what you pay in interest will decline and you’ll make bigger dents into your principal.
Car loans
Most car loans are simple interest loans. You’ll pay what you borrow plus a flat percentage in interest, generally ranging from 2.5% to 7%, depending on your credit score, loan term and type of car loan.
A car loan is front-loaded, which means more of your auto loan payment applies to interest at the beginning. As you pay down the interest, more of your money goes toward the principal balance until you’re squared away.
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.
Account type. 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 features.
Compare interest rates across loans, credit cards and savings accounts
Use the table to compare interest rates on savings accounts, personal loans and credit cards. Sort by key features, including fees and minimum opening deposits.
We update our data regularly, but information can change between updates. Confirm details with the provider you're interested in before making a decision.
Before signing any financial agreement, make sure you understand all of its associated terms. Use that knowledge to shop around and find the best deal.
Frequently asked questions
Since interest rates can vary significantly from bank to bank, shop around to find the best deal. Don’t forget to consider online savings accounts because they tend to have the most competitive interest rates, although you won’t have a branch you can visit for in-person help. For more tips, read our guide to getting the best interest rate.
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. Be sure to 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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A percent, or even half a percent, difference can add up to significant savings over time. For example, Rebecca puts $40,000 into a savings account with a 2.50% APY, and she adds $750 each month. After five years, she’s made $8,200.45 in interest.