{"id":23561,"date":"2026-03-09T18:02:27","date_gmt":"2026-03-09T18:02:27","guid":{"rendered":"https:\/\/budgetadirect.com\/?p=23561"},"modified":"2026-03-09T18:02:28","modified_gmt":"2026-03-09T18:02:28","slug":"what-is-interest-and-how-does-it-work","status":"publish","type":"post","link":"https:\/\/budgetadirect.com\/?p=23561","title":{"rendered":"What Is Interest And How Does It Work?"},"content":{"rendered":"<div>\n<div id=\"block_9738c95af1264d6d6e07de379b0c9b57\" class=\"key-takeaways sm:border-l-4 border-(--accent) sm:pl-8 my-8 relative\" style=\"--accent: var(--color-blue-medium)\">\n    <!-- htmlmin:ignore --><\/p>\n<h2 class=\"heading-4 mt-0 mb-4 text-crop-none max-sm:flex max-sm:items-center max-sm:gap-4\" id=\"key-takeaways\" data-position=\"0\" data-beam-element-viewed=\"\" data-id=\"br-h2-0-onpage-placement\" data-type=\"h2\" data-location=\"Editorial\" data-name=\"h2_all\" data-text=\"Key takeaways\" data-outcome=\"\">\n    <span class=\"shrink-0\">Key takeaways<\/span><br \/>\n        <span class=\"max-sm:h-0.5 max-sm:w-full max-sm:w-full max-sm:bg-(--accent) max-sm:rounded-full max-sm:block\"\/><br \/>\n    <\/h2>\n<p>    <!-- htmlmin:ignore --><\/p>\n<ul class=\"flex flex-col text-gray-700 mb-0 gap-2 list-disc\">\n<li class=\"pl-4 relative marker:text-(--accent)\">\n                                                            Interest can be charged when you borrow money or earned when you save.\n                                                <\/li>\n<li class=\"pl-4 relative marker:text-(--accent)\">\n                                                            When you charge something on a credit card or take out a loan from a financial institution (student loan, auto loan, mortgage, etc.), you\u2019re charged interest for borrowing that money.\n                                                <\/li>\n<li class=\"pl-4 relative marker:text-(--accent)\">\n                                                            You can also earn interest in the form of a yield on interest-bearing accounts, such as savings accounts.&#13;<\/p>\n<\/li>\n<\/ul>\n<\/div>\n<p>Interest is either the cost of borrowing money or the reward for saving or investing it \u2014 depending on which side of the transaction you\u2019re on.<\/p>\n<p>For borrowers, interest is a percentage of the amount of a loan you\u2019ll owe across a year, paid to the lender. This percentage is known as the interest rate on the loan. For investors or savers, interest comes in the form of an annual percentage yield (APY).<\/p>\n<p>For example, a bank will pay you interest when you deposit your money in a high-yield savings account. The bank pays you to hold and use your money to invest in other transactions. Conversely, if you borrow money to pay for a large expense, the lender will charge you interest on top of the amount you borrowed.<\/p>\n<p>Understanding how interest works is essential to making smart financial decisions. In this guide, we\u2019ll break down the basics of interest, how it\u2019s calculated and what it means for your loans, credit cards, savings accounts and more.<\/p>\n<h2 id=\"borrowing\" data-position=\"1\" data-beam-element-viewed=\"\" data-id=\"br-h2-1-onpage-placement\" data-type=\"h2\" data-location=\"Editorial\" data-name=\"h2_all\" data-text=\"How interest works when borrowing\" data-outcome=\"\">How interest works when borrowing<\/h2>\n<p>Whenever you borrow money, you\u2019re required to pay the principal (the loan amount) back to your lender. You\u2019ll also need to pay your lender the interest, typically an annual percentage of the principal, set for the loan. These loans come in many forms, including credit cards, student loans, car loans, mortgages and personal loans. Understanding how the interest terms and repayment requirements work is essential to managing debt wisely.<\/p>\n<p>For example, let\u2019s say you borrow $10,000 from your bank in a straightforward loan with a 10% interest rate per year, and the loan is repaid over five years. In this example, you\u2019d pay about $2,748.23 in interest over the life of the loan.<\/p>\n<p>You can use Bankrate\u2019s loan calculator to estimate how much interest you would pay on a loan.<\/p>\n<section class=\"editorial-insight-box --insight-box +mg-vertical-md\" data-template=\"insight_box\">\n<div class=\"card-body border-l-4 border-blue-800\">\n<div class=\"content-wrapper\">\n<p>\n                    Expert advice: Interest vs. APR\n                <\/p>\n<div class=\"content wysiwyg wysiwyg--flush\">\n<p>\u201cIn addition to interest, a lender might charge other fees. That\u2019s why I recommend comparing annual percentage rates (APRs) among lenders, not just interest rates. An APR factors in both the interest rate and any other fees, helping you compare total costs more accurately.\u201d<\/p>\n<p>\u2014 Pippin Wilbers, Bankrate editor<\/p>\n<\/p><\/div>\n<\/p><\/div>\n<\/p><\/div>\n<\/section>\n<h2 id=\"saving\" data-position=\"2\" data-beam-element-viewed=\"\" data-id=\"br-h2-2-onpage-placement\" data-type=\"h2\" data-location=\"Editorial\" data-name=\"h2_all\" data-text=\"How interest works when saving\" data-outcome=\"\">How interest works when saving<\/h2>\n<p>You can earn interest in savings products like a high-yield savings account, money market account or certificate of deposit (CD). There are also traditional savings accounts, but they earn much less interest compared to high-yield savings accounts.<\/p>\n<p>Most savings accounts offer compound interest (more on that below). The more you put into savings, the more your savings compound, and the more interest you earn in your account.<\/p>\n<h3>Interest vs. APY<\/h3>\n<p>If you\u2019re an investor or saver, understanding APYs can help you grow your wealth over time. An APY accounts for both the simple interest rate and the additional interest you earn due to compounding. (Think of compounding as earning interest on your interest.)\u00a0<\/p>\n<p>When you open a deposit product, like a savings account or certificate of deposit, the listed APY tells you how much you will earn over a year. An APY makes doing the math to figure out what you\u2019ll earn simple. For example, suppose you have a savings account with an APY of 5%. If you had $10,000 in the account, you\u2019d earn 5% of that amount \u2014 $500 \u2014 in interest after one year.<\/p>\n<h2 id=\"determined\" data-position=\"3\" data-beam-element-viewed=\"\" data-id=\"br-h2-3-onpage-placement\" data-type=\"h2\" data-location=\"Editorial\" data-name=\"h2_all\" data-text=\"How are interest rates determined?\" data-outcome=\"\">How are interest rates determined?<\/h2>\n<p>When you borrow money, your financial health and credit history are the main factors determining the rate you get. When you save money, the financial institution sets rates based on economic factors.\u00a0<\/p>\n<h3>Credit products<\/h3>\n<p>With credit products, like a credit card or loan, each lender has a range of possible rates that depend on market conditions. But they use a number of different factors to determine your interest rate within that range, including your credit score and debt-to-income ratio. Lenders use these to evaluate whether they can count on you to repay the amount you borrow. If they think you\u2019re likely to miss payments or fail to repay the loan, they will charge higher interest to make up for that risk.<\/p>\n<p>Depending on the loan product, the range of possible rates can be dramatic. Say you have excellent credit and plenty of room in your budget. You might get a five-year, $30,000 car loan with a fixed 6% interest rate and a $580 monthly payment. But if your credit is poor, you might get a 13% interest rate on the same loan, bring your monthly cost to $683.<\/p>\n<h3>Deposit products<\/h3>\n<p>With deposit products, like high-yield savings and CDs, interest rates depend less on you and more on the economy: The rates financial institutions advertise change based on market conditions and what competitors are offering. You might get a higher rate for depositing more money or having another account with the same bank, but your personal finances don\u2019t factor in.\u00a0<\/p>\n<section class=\"editorial-insight-box --insight-box +mg-vertical-md\" data-template=\"insight_box\">\n<div class=\"card-body border-l-4 border-blue-800\">\n<div class=\"content-wrapper\">\n<p>\n                    Fixed vs. variable rates\n                <\/p>\n<div class=\"content wysiwyg wysiwyg--flush\">\n<p>A fixed rate doesn\u2019t change, while a variable rate may go up or down over time. You\u2019re likely to see fixed rates on auto loans and personal loans. Variable rates are common on savings accounts and credit cards. You can choose between both for student loans and mortgages. For CDs, you can lock in a rate for a set amount of time, but the rate may change if you renew the CD.<\/p>\n<\/p><\/div>\n<\/p><\/div>\n<\/p><\/div>\n<\/section>\n<h2 id=\"simple-compound\" data-position=\"4\" data-beam-element-viewed=\"\" data-id=\"br-h2-4-onpage-placement\" data-type=\"h2\" data-location=\"Editorial\" data-name=\"h2_all\" data-text=\"Simple vs. compound interest\" data-outcome=\"\">Simple vs. compound interest<\/h2>\n<p>For both deposits and credit products, there are two basic methods to calculate interest: Simple interest and compound interest.<\/p>\n<div class=\"DefinitionList mb-8 DefinitionList--list\">\n<dl>\n<div class=\"Definition-item flex\">\n<dt class=\"text-gray-900\">Simple interest<\/dt>\n<dd class=\"text-gray-700\">\n<p>Simple interest is calculated only on the original amount of money you deposit or borrow (the principal). While it\u2019s rarely used in savings accounts today, it\u2019s still a helpful concept for understanding interest.<\/p>\n<p>For example, if you deposit $1,000 into an account that pays 4% simple interest annually, you\u2019ll earn $250 after five years.<\/p>\n<p>Formula: $1,000 \u00d7 0.04 \u00d7 5 = $200 in interest.<\/p>\n<\/dd>\n<\/div>\n<div class=\"Definition-item flex\">\n<dt class=\"text-gray-900\">Compound interest<\/dt>\n<dd class=\"text-gray-700\">\n<p>Compound interest is calculated on both your original principal and the interest you\u2019ve already earned. Most savings accounts, investment accounts and credit cards use compound interest.<\/p>\n<p>Calculating the same $1,000 example at 4% interest compounded annually, you\u2019d earn about $217 in interest over five years \u2014 slightly more than with simple interest. Over longer periods or with more frequent compounding, the difference can grow significantly.<\/p>\n<p>Note: This example assumes a single deposit with no additional contributions, to keep the comparison between simple and compound interest straightforward.<\/p>\n<\/dd>\n<\/div>\n<\/dl>\n<\/div>\n<section class=\"editorial-insight-box --insight-box +mg-vertical-md\" data-template=\"insight_box\">\n<div class=\"card-body border-l-4 border-blue-800\">\n<div class=\"content-wrapper\">\n<p>\n                    Calculating compound interest\n                <\/p>\n<div class=\"content wysiwyg wysiwyg--flush\">\n<p>The math to calculate compound interest is a little more complicated. Check out our compound interest calculator for a full explanation \u2014 or let it do the math for you.<\/p>\n<\/p><\/div>\n<\/p><\/div>\n<\/p><\/div>\n<\/section>\n<p>For large loans with high interest extended over a long term, the increase in total amount paid when interest is compounded can be significant. For this reason, it\u2019s always important to ask your lender or your bank whether a loan or your savings account will have simple or compound interest.<\/p>\n<div class=\"HelpfulCTA mx-auto flex flex-col items-center gap-6 my-6 py-12 text-base border-y border-gray-200\" data-helpful-cta=\"\" data-beam-element-viewed=\"\" id=\"did-you-find-this-helpful\" data-type=\"cta\" data-location=\"article-bottom\" data-position=\"banner\" data-text=\"Did you find this page helpful?\">\n<div class=\"HelpfulCTA-initial w-full flex flex-col items-center gap-4\" data-cta-initial=\"\">\n<div class=\"HelpfulCTA-question text-lg font-bold text-center text-gray-900\">\n            Did you find this page helpful?<\/p>\n<div id=\"F7blwd5xOV\" class=\"hidden\">\n<div class=\"wysiwyg wysiwyg--sm wysiwyg--flush max-w-xs\">\n<p class=\"mb-6 text-base\">\n                            <strong class=\"block font-bold text-gray-900\">Why we ask for feedback<\/strong><br \/>\n                            Your feedback helps us improve our content and services. 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0-.323.322c-.075.15-.075.603-.075 1.226v7.68c0 .623 0 1.075.075 1.226.075.14.183.247.323.322.15.075.603.075 1.228.075h.16c.625 0 1.078 0 1.228-.075a.778.778 0 0 0 .324-.322c.075-.151.075-.603.075-1.227V5.423c0-.623 0-1.076-.075-1.226a.722.722 0 0 0-.324-.322c-.15-.076-.603-.076-1.227-.076h-.161Z\" class=\"icon-base\"\/><\/svg><\/span> <span class=\"text-base leading-4\">No<\/span><br \/>\n            <\/button>\n        <\/div>\n<\/p><\/div>\n<p>    <!-- Yes Form --><\/p>\n<p>    <!-- No Form --><\/p>\n<div class=\"HelpfulCTA-thankyou flex flex-col items-center gap-2\" data-cta-thankyou=\"\" style=\"display:none;\">\n<p>Thank you for your<br \/>\n            feedback!<\/p>\n<p>Your input helps us improve our<br \/>\n            content and services.<\/p>\n<\/p><\/div>\n<\/div><\/div>\n<p>Read the full article <a href=\"https:\/\/www.bankrate.com\/banking\/savings\/what-is-interest\/\" target=\"_blank\" rel=\"noopener\" rel=\"nofollow\">here<\/a><\/p>\n","protected":false},"excerpt":{"rendered":"<p>Key takeaways Interest can be charged when you borrow money or earned when you save. When you charge something on a credit card or take out a loan from a financial institution (student loan, auto loan, mortgage, etc.), you\u2019re charged interest for borrowing that money. You can also earn interest in the form of a<\/p>\n","protected":false},"author":1,"featured_media":23562,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[58],"tags":[],"class_list":{"0":"post-23561","1":"post","2":"type-post","3":"status-publish","4":"format-standard","5":"has-post-thumbnail","7":"category-homes"},"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v22.2 - https:\/\/yoast.com\/wordpress\/plugins\/seo\/ -->\n<title>What Is Interest And How Does It Work? | BudgetADirect<\/title>\n<meta name=\"description\" content=\"Key takeaways Interest can be charged when you borrow money or earned when you save. 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