Understanding Interest Rates
ByASB April 12, 2021 | 5 min read Personal
You might have heard about interest rates but do you really know what they are and how they can help your finances? You might know that interest is the money you pay to borrow on a loan, or that some types of accounts (like savings accounts) allow you to earn interest on your money. The specific details of bank interest rates, however, might have you feeling a little confused.
We’re here to help you understand interest rates and how they work. Let’s take a closer look at interest rates — what they are, terms to know and when you’ll pay versus earn interest.
What is interest?
Interest is the price a borrower has to pay to use someone’s money. For example, when you take out a car loan, you’re borrowing the lender’s money to pay for your new vehicle. The interest you pay on the loan is the lender’s price to let you use their money. On the other hand, if you lend a friend money and ask them to pay extra when paying you back, you’re earning interest on the loan.
Generally, interest rates are calculated by dividing the annualized finance charge (cost of credit) by the total loan amount and expressed as a percentage.
Common interest rate terms
We rounded up some common terms often used when talking about bank interest rates, and what they mean:
Compound Interest: Compounding interest is when the interest you’ve earned starts earning interest as well. For example, if you have $100 and earn 10% interest on it over the course of a year, at the end of the year, you’ll earn $10 from interest, making your final balance $110. The next year, you’ll earn 10% on $110 instead of just $100 so you’ll end the year with $121 due to annual compounding of interest.
Annual Percentage Rate (APR): This is the percentage charged annually to a borrower. It’s the actual yearly cost of a loan, including costs like loan fees. It doesn’t include compounding interest.
Annual Percentage Yield (APY): This is the annual percentage of money earned from interest on a savings deposit over the course of one year, including compounding interest.
Fixed Interest Rate: This is an interest rate that stays the same for a specific period of time for the length of a loan or account. That means your interest rate won’t change for the life of your loan or account. For example, if you’re approved for a home loan with a fixed 5% interest rate on a 30-year term, your home loan interest rate will remain fixed for the entire 30 years, even if current interest rates change.
Variable Interest Rate: The opposite of a fixed interest rate, a variable interest rate can change over the course of your account. Credit cards usually have a variable interest rate. For example, if your credit card interest rate is 10% when you first open the account, after three months, your credit card may raise the interest rate to 18%. However, a year later, the rate could drop down to 15%.
Principal: This is the outstanding unpaid amount of money you borrow or balance of money you deposit into an account.
Installment Debt: Also called installment loans, this is a type of loan that has a repayment schedule and fixed payment amount. Most regular loans are installment loans, such as home loans and personal loans.
Revolving Debt: Revolving debt lets you borrow as much as you want up to a certain credit limit. After repaying what you’ve borrowed and replenishing your account’s available balance, you can borrow more. Credit cards are a type of revolving debt. For example, if you have a $1,000 credit limit on a credit card and spend $700, you’ll have $300 left of credit to borrow. If you pay off the $700 you’ve already spent, your available credit will go back up to $1,000.
When do I pay interest?
You usually have to pay interest when you borrow money, such as installment debt and revolving debt. The good news is, interest costs are often included in your payment amount, making it easy to pay your interest along with your principal loan balance.
Common types of loans or debt where you can expect to pay interest include:
Home Loans: A home loan, also known as a mortgage loan, is the loan you use to buy a house. Mortgage interest rates can vary widely over the years, so many home buyers lock in their home loan interest rate with a fixed interest rate when interest rates are low.
Personal Loans: You can use personal loans to buy just about anything. Whether you want to buy new living room furniture or cover an unexpected medical bill, a personal loan can help you pay for expenses. Be sure to check out the latest interest rates before applying for your loan.
Personal Line of Credit: A personal line of credit is like a credit card. If approved, you’ll get a credit limit for your personal line of credit. You’ll pay interest only on the amount you borrow against your credit limit.
When do I earn interest?
Savings accounts are usually the easiest way to earn interest on your money. There are a variety of savings accounts you can use to help you earn more as you save more. Many savings accounts also compound your interest — meaning you earn more as your interest earnings grow over time.
Traditional Savings Account: A regular savings account through a bank like ASB makes it easy to save for the future — whether you’re saving for emergencies, a new car, or long-term goals like a new house.
Certificate of Deposit (CD): A CD is a type of deposit account that earns guaranteed returns over a specific period. You’ll choose your length of term and get a guaranteed interest rate during the duration of the term. However, if you withdraw your money before the scheduled maturity date, you could incur early withdrawal fees.
Money Market Account: This is a savings account that lets you earn higher interest rates on higher balances. Money market accounts also let you access your money by check, unlike most savings accounts.
Learning about bank interest rates
Want to know more about bank interest rates in Hawaii? Whether you’re looking for a great low rate on a home loan or want to earn compound interest on the money you save, ASB has the answers to all of your interest rate questions. Make an appointment with our helpful bankers at one of our branches today to learn more.