An interest rate is a percentage that describes how much a borrower will be pay for a loan. It's often quoted as an annual rate, but depending on the situation, interest can be quoted and calculated in a variety of ways.
When you borrow money, you pay interest to the lender. When you deposit money in an interest-bearing savings account, you're essentially lending money to the bank, and you're earning interest on it. Some banks offer higher interest rates than others.
When you deposit money at the bank, you may earn interest on that money— especially if you're depositing it into a savings account or certificate of deposit (CD). However, accounts that allow daily spending, such as checking accounts, often don’t pay interest.
The bank pays you to keep your funds on deposit—and sometimes uses those funds to earn more money by lending to other customers (offering auto loans or credit cards, for example) or investing in other ways.
The interest you earn at a bank or credit union is typically quoted as an annual percentage yield (APY), which takes compounding into account. The actual interest rate you earn is often lower than the quoted APY, but after compounding—earning interest on top of interest you previously earned—you can earn the full APY.
If you leave your money untouched, you should earn a return equal to the APY over one year. Because the rate is a percentage, you can calculate how many dollars you’ll earn no matter how much you deposit. The chart below breaks down how much you can potentially earn in a savings account with 2% APY over the course of 30 years.
When you borrow money, you pay lenders to do so, and it's often expressed in a percentage of the amount you borrow—known as an interest rate.
An interest rate is different from an annual percentage rate (APR), which you'll often see quoted for consumer loans. An APR tells you how much you can expect to pay for every year you use the money, and it includes fees above and beyond interest costs.
When comparing rates, look closely at all of the costs involved. Always run the numbers yourself and compare options before you commit.
It’s usually best to pay interest at the lowest rate possible. However, there may be situations when you prefer (or simply need to accept) a higher interest rate loan—especially when your credit is poor. Credit cards often have higher interest rates as well.
Factors Affecting the Interest You Earn
The interest rate you earn on your money can depend on the policies of the bank or institution that's holding it. However, changes to the Federal Reserve's benchmark interest rate have a big impact on most interest-bearing savings accounts.
When the Federal Reserve raises interest rates, then you may see banks raise theirs as well. When it lowers interest rates, banks may also lower theirs.
Factors Affecting the Interest You Pay
Interest rates on loans can vary widely, and they often depend on what type of loan you're getting.
Most lenders look at borrower risk—how likely you are to pay back the loan. They often use your credit score as an indicator of this. Potential borrowers with higher scores tend to get more favorable interest rates.
To get an idea of how your credit score may affect the interest rate you get on a personal loan and therefore, what you must pay, plug in different answers for your credit score in the calculator below.
Another factor that helps lenders determine interest rates is the loan term—how long you're looking to borrow the money. Usually, the shorter the term, the lower the interest rate.
Loans can have a fixed interest rate, meaning it won't change over the life of the loan, or a variable interest rate, meaning that it can rise or fall during the life of the loan, usually as the index rate changes.
Credit card interest rates are often much higher than rates on other types of loans, such as personal loans, mortgages, and auto loans. That's because a credit card loan is considered revolving debt: A loan with a spending limit that automatically renews once you pay it off. If you don't pay it off right away, then you usually pay a hefty interest rate on the balance.