What Is Interest?

Interest is one of two things. If you’re taking out a loan or paying for a credit card, it’s the cost of borrowing money. If you have an interest-bearing account, it’s money you earn on your balance. Knowing this difference is crucial since a high interest rate can be good if earned. It can be less than ideal if paid.

Learn how simple and compound interest work in practice, as well as how federal changes to interest rates can impact borrowers and lenders.

Key Takeaways

• Interest cuts both ways. It's the cost of borrowing when you owe it and money you earn when you save, so a high rate helps you on savings but hurts you on debt.

• APR is what you pay, APY is what you earn. APR bundles the interest rate plus certain lender fees, while APY reflects the interest you earn including compounding.

• Compound interest grows faster than simple interest. Simple interest applies only to your principal, while compound interest is calculated on your principal plus previously earned interest.

Summary generated by AI, verified by MoneyLion editors

Examples of Interest

Interest is most often expressed as a percentage. As a borrower, you might have seen it called an annual percentage rate (APR). APR is interest plus any lender fees associated with borrowing money. It’s shown as a yearly rate.

APR

You’ll usually see APR on financial products, like:

• Credit cards: These tend to have some of the highest interest rates. In fact, the average credit card APR hovers at around 22% for accounts carrying a balance, according to the Federal Reserve. Rates are most often variable, meaning they can change over time.

• Mortgage loans: When you take out a home loan, double-check the interest rate first. Your rate can heavily impact your monthly payments (and the total cost of homeownership). The average APR on a 30-year, fixed-rate loan is 6.49% as of July 16, 2026, according to Freddie MAC.

• Auto loans: An auto loan is a shorter term loan, usually with a fixed interest rate. This means the rate doesn’t change. Rates vary for used and new vehicles, but it’s not uncommon to find ones ranging from around 6% to 11%. They’re often higher on longer-term loans.

• Student loans: Interest rates differ across federal and private student loans. As of July 1, 2026, federal loans have a fixed interest rate of 6.52% (undergrad), 8.07% (grad) to 9.07% (PLUS).

And then there’s interest paid to you on an account. This is often called annual percentage yield (APY). It accounts for compounding frequency. It reflects the actual interest rate and, like APY, it’s expressed as a yearly rate.

APY

APY is most commonly found in:

• Interest-bearing checking and savings accounts: Most savings (and some checking) accounts earn interest on the existing balance. The greater the account balance, the higher the potential earnings. The highest APYs are usually reserved for high-yield savings accounts, which, as of June 15, 2026, cap out at 4.37%.

• Certificates of deposits (CD): CDs are like traditional savings accounts, but they may have a higher APY. The trade-off is that you must agree to keep a certain amount of money in the account until a specific date. Early withdrawal could mean a hefty penalty.

A higher APY is usually a good thing for you since it means your money can potentially earn more interest. Conversely, a higher APR primarily benefits the lender since they’re getting more money from you in exchange for financing.

Worth noting is that you could earn interest on investments, like 401(k)s or stocks and bonds. Some of these options are riskier than others. Interest is also generally variable rather than fixed.

How To Calculate Interest

Interest is a percentage of the amount borrowed, or principal balance. How it’s calculated depends on the type of interest you’re dealing with, but the simple calculation is this:

• Multiply the principal balance by the interest rate

Say you have $1,000 invested in a five-year CD earning 4% interest. Using the above calculation (for simple interest), your account would earn $40 each year. After five years, you’d have $200 in total interest (and $1,200 in the account).

When borrowing money, you may need to take other costs into account. For instance, a mortgage APR often includes the interest rate, origination fees, discount points and closing costs.

Say you take out a $350,000 mortgage with a 30-year term and a fixed APR of 6%. Excluding taxes and other fees, your total interest costs over the life of the loan would be $405,434. You can lower this total by prepaying your mortgage.

Other types of financing use their own formula. Take credit cards for example. Many card issuers charge interest based on your average daily account balance. The higher your balance, and the longer it takes for you to pay it all off, the more interest you’ll ultimately pay.

Simple vs. Compound Interest

Simple interest is based on the principal amount. Compound interest is based on the principal plus previously earned interest. It’s basically the interest earned on interest.

The above example of the five-year CD was based on a simple interest rate. The interest earned is determined by multiplying the principal by the interest rate. The balance goes up, but the amount of interest earned each year technically remains the same.

Put simply:

• The CD with $1,000 and a 4% APY earns $40 yearly.

• You get $200 by the end of five years.

It works similarly for loans. Say you take out a $10,000 personal loan with a five-year term and simple interest rate of 8%. Your total interest payments would be $2,100 annually.

With compound interest, you multiply the principal by the interest rate plus earned interest. Compound interest can be calculated daily, weekly, monthly or even annually. That means as you pay off the loan (or deposit more in a savings account) the rate is recalculated based on the new principal.

When you’re a borrower, getting charged compound interest means higher overall costs. When you’re earning it, however, you can earn more at a faster rate.

Federal Interest Rates

Financial institutions use many factors to set interest rates, including the Federal Reserve. When the Fed lowers the federal funds rate, banks and other lenders tend to lower their own rates. This effectively reduces the cost of borrowing money. But when the Fed increases the federal funds rate, interest rates tend to rise as well.

It’s not just the Federal Reserve impacting interest rates. Other economic factors, like inflation and GDP growth, can as well. When there’s a recession, rates usually drop. In times of high inflation or economic growth, rates may rise.

The Bottom Line

Interest is either what helps your money grow, or what increases the costs of taking out a loan or credit card. A higher interest rate is good when you’re on the receiving end — not so much when you’re paying.

When applying for credit, or shopping around for interest-bearing accounts, consider the interest rate you’re getting. Also, make sure you know whether it’s simple or compound interest since that can make a big difference in what you ultimately pay (or earn).

FAQ

Is interest good or bad?

Interest isn’t inherently good or bad. It really depends on which side you’re on. If you’re the borrower, a high interest rate could be considered bad. But even then, it also depends on how prepared you are for it and if it’s worth what you’re getting in return. If you’re the recipient, a higher interest rate is usually a good thing.

What’s 5% interest on $5,000?

Using simple interest, it’s $250 annually. That means you’ll get an additional $250 per year on your original balance.

Do you lose money from interest?

If you’re borrowing money, you’re paying interest on the amount borrowed. So, in a way, you could view it as losing money. If you’re earning interest on a savings or investment account, you’re technically gaining instead.

What interest is too high?

This depends on the type of debt. When you’re shopping around for financing, compare the interest rates you’re seeing against the averages. Aim for a rate below the average. For example, the average APR on a credit card is around 22%. If a card issuer is offering a higher variable rate, you might want to look elsewhere.

Does credit score affect interest rates?

Your credit does affect the rate you get. Better credit usually means lower interest rates. But there are other factors at play, like the current federal funds rate and your debt-to-income ratio.

Key Terms

• Interest — The cost of borrowing money, or the money you earn on a deposit balance, usually shown as a percentage.

• Annual percentage rate (APR) — The yearly cost of borrowing, including the interest rate plus certain lender fees like origination fees.

• Annual percentage yield (APY) — The yearly rate of return on savings or investments, including the effect of compound interest.

• Principal — The original amount you borrow or deposit, before interest is added.

• Simple interest — Interest calculated only on the principal balance.

• Compound interest — Interest calculated on the principal plus previously earned interest, which grows a balance faster over time.

• Fixed vs. variable rate — A fixed rate stays the same for the life of a loan, while a variable rate can rise or fall with a benchmark like the federal funds rate.

• Federal funds rate — The Federal Reserve's benchmark rate that influences what lenders charge and what savers earn.

Sources

• Federal Reserve — Consumer Credit (G.19) report

• Federal Student Aid — Interest Rates for Federal Direct Loans (2026-27)

• CFPB — What is the difference between a loan interest rate and the APR?

Summary generated by AI, verified by MoneyLion editors