What is the interest rate on loans or savings accounts?

What Interest Rates Mean at the Bank

The interest rate is a percentage that describes how much will be paid to the borrower when borrowing. It is usually quoted as an annual rate, but interest can be quoted and calculated in different ways depending on the situation.

Earning Interest

When you deposit money into a bank, you may earn interest on that money – especially if you deposit it into a savings account or a certificate of deposit (CD). However, accounts that allow for daily spending, such as checking accounts, often do not pay interest.

The bank pays you to keep your money deposited, and sometimes it uses that money to earn more money by lending it to other clients (such as offering car loans or credit cards, for example) or investing in other ways.

Interest that you earn at the bank or credit union is usually quoted as an annual percentage yield (APY), which accounts for compounding. The actual interest rate you earn may be lower than the quoted APY, but after compounding – earning interest on the interest you’ve already earned – you can earn the full APY.

If you leave your money untouched, you should earn a yield equal to the APY over one year. Because the percentage is a fraction, you can calculate the amount of dollars you will earn regardless of the deposit amount. The table below shows how much money you can earn in a savings account with a 2% APY over 30 years.

Paying Interest

When you borrow money, you pay lenders to do so, and this is usually expressed as a percentage of the amount borrowed – known as the interest rate.

The interest rate is different from the annual percentage rate (APR), which is often quoted for consumer loans. The APR tells you how much you can expect to pay each year you use the money, and it includes fees on top of the interest costs.

Note: When comparing rates, carefully look at all the costs involved. Always calculate the numbers yourself and compare options before committing.

It is usually best to pay interest at the lowest rate possible. However, there may be times you prefer (or simply need to accept) a loan with a higher interest rate – especially when you have bad credit. Interest rates on credit cards are often higher as well.

Factors That Affect the Interest You Earn

The interest rate you earn may depend on the policies of the bank or institution you are with. However, changes in the Federal Reserve’s benchmark interest rate have a significant impact on most interest-bearing savings accounts.

When the Federal Reserve raises interest rates, you may see banks raise their rates as well. When the Federal Reserve lowers interest rates, banks may also lower their rates.

Factors That Affect the Interest You Pay

Interest rates on loans can vary significantly and often depend on the type of loan you are getting.

Lenders often look at the borrower’s risk – how likely it is that the loan will be repaid. They often use your credit score as an indicator of this. Potential borrowers with higher scores tend to receive more favorable interest rates.

To get an idea of how your credit score affects the interest rate you will receive on a personal loan and thus what you will pay, input different answers for your credit score into the calculator below.

Another factor that helps lenders determine interest rates is the loan term – the length of time you wish to borrow. Generally, the shorter the term, the lower the interest rate.

Note:

Loans can have a fixed interest rate, meaning it will not change over the life of the loan, or a variable interest rate, meaning it can rise or fall during the life of the loan, usually with changes in the index rate.

Credit card interest rates are typically much higher than the interest rates on other types of loans, such as personal loans, mortgages, and auto loans. This happens because a credit card loan is considered revolving debt: a loan that automatically renews once you pay it off. If you do not pay it off right away, you typically pay a very high-interest rate on the balance.

Sources

The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts in our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.

Merriam-Webster. “Interest Rate.”
Discover. “How Does Interest Work on a Savings Account? Your Guide Here.”
Consumer.gov. “Using Credit.”
Consumer Financial Protection Bureau. “What is the difference between a mortgage interest rate and the annual percentage rate?”
U.S. Securities and Exchange Commission. “Paying Off Credit Cards or Other High-Interest Debt.”
Discover. “What a Rate Increase Might Mean for Your Savings Portfolio.”
Experian. “What Factors Do Lenders Consider When Determining My Interest Rate?”
Consumer Financial Protection Bureau. “What is the difference between fixed and variable interest rate car financing?”
Debt. “Revolving Credit: What It Is and How It Works.”

Source: https://www.thebalancemoney.com/what-is-the-interest-rate-on-loans-or-savings-315437