Interest Rates 101

But what does it mean?

Well, to put it simply … it means one of two things.

1. It's an interest rate where you receive money – if it's a savings account.

2. It's an interest rate where you pay money – if it's a loan account - like a credit card, car or home loan.

An interest rate either makes you money or costs you money.

How does it work?

Let's start with an interest rate which makes you money. Much more interesting.

You start with a savings account. This is your 'rainy' day account or, your 'fun stuff' account. The extra money you squirrel away to buy something special. It can be a simple transactional account or, if you're really committed, a term deposit where you lock it away and can't be tempted to access it.

A savings interest rate is how much you will receive, based on the interest rate and the amount you have in the account.

If your savings account has an interest rate of 4.00% p.a., this means the money you have saved will earn you interest of 4.00% of that amount p.a. (per annum or for the year!)

If you keep $1,000 in this account for the entire year, it will earn you an extra $40 dollars in that year. For doing nothing except sitting in there. There's your motivation for not withdrawing it. And the more you save in that account, the more you receive.

Most savings accounts pay you interest each month (unless they are term deposits). So even though the interest rate is a per annum (every year) rate, you will get a monthly interest payment each month, which is a fraction of the yearly interest amount.

How do I calculate my interest earned?

There are heaps of tools online that can help you figure out how much interest you can earn based on what you have in your savings. The moneysmart savings goal calculator is handy.