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What is the Interest Rate on Loans or Savings?

What Interest Rates Mean at the Bank

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An interest rate is a number that tells you how much it costs to borrow money. Lenders usually want to earn something in return for handing over cash, so they name their price with an interest rate. Learn what the interest rate at your bank means for your finances.

What is the Interest Rate You Earn?

When you deposit money at the bank, you may earn interest on that money -- especially in savings accounts or certificates of deposit (CDs). In a sense, you’re lending money to the bank so they can use it elsewhere. In return, you get interest income. The interest rate is generally quoted as annual percentage yield (APY). For example, a savings account might pay 3% APY.

What does that interest rate mean? If you leave your money in the bank, you can 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. You can also have an online calculator what a given interest rate will generate for you. What will the interest rate in the example above produce? If you deposit $100 at 3% APY, you’ll earn $3 after one year.

When an interest rate is quoted with APY, your money compounds -- you earn interest on your initial deposit plus previous interest payments. For more on this, see a visual example of how compounding works. Money doesn’t always compound. Some loans and deposits use simple interest instead.

What is the Interest Rate You Pay?

When you borrow money, you generally pay interest. Lenders want to be compensated for letting you use their assets. Interest rates on consumer loans are often quoted with an annual percentage rate (APR). That number tells you how much you can expect to pay for every year you use the money, and includes fees above and beyond interest costs.

When you pay interest, the money is gone for good. It may be possible to deduct some interest costs, but that’ll only cover a portion of your total cost. It’s usually best to pay interest at the lowest rate possible. However, there are a few exceptions. High interest rate loans may fit your needs better depending on other terms, especially for short term loans. Also, lenders can manipulate things to make it look like you’re paying less than you are (by quoting a low interest rate but jacking up the price, for example). Always run the numbers yourself and compare options before you commit.

Why do Interest Rates Change?

Rates can change over time. What makes interest rates move? A few factors that affect them are:

  • Economic conditions
  • How risky the borrower is (good credit means lower interest rates)
  • How risky the loan is (short term loans and loans with collateral generally have lower rates)
  • How eager the lender is to make loans (or gather deposits, if a bank)

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