An interest rate is the price of money. When you borrow, you pay it. When you save, you earn it.
How it works
Interest is usually shown as an annual percentage. Two terms are worth knowing:
- APR (annual percentage rate) is the yearly cost of borrowing, including some fees. You’ll see it on loans and credit cards.
- APY (annual percentage yield) is what you earn on savings in a year, including the effect of compounding.
Rates can be fixed, staying the same for the life of the loan or deposit, or variable, rising and falling with the market.
Where rates come from
The Federal Reserve sets a target for the federal funds rate, the rate banks charge each other for overnight loans. That target influences many other rates, including credit cards, auto loans and savings accounts. Mortgage rates are also shaped by the bond market and inflation expectations. Your personal rate depends on your credit score, income, debt and the type of loan.
Why it matters to you
Small differences add up. On a $10,000 credit card balance, the difference between 15% and 25% APR is about $1,000 a year in interest. According to the Federal Reserve, the average rate on credit card accounts that are charged interest is around 21%, much higher than most savings accounts pay. That’s why paying off high-interest debt is often one of the best “returns” available.
How to make rates work for you
- Pay down high-rate debt first.
- Improve your credit score to qualify for lower borrowing rates.
- Shop around: rates vary widely between lenders and banks.
- Keep savings somewhere that pays a competitive APY.
See how your debt compares with the national average. Get your Wealth Report Card.
Source: Federal Reserve G.19 Consumer Credit release. Examples are hypothetical and for educational purposes only.