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.

It shows how much you can earn in a month or year while building up your savings. It’s great for when you are trying to save for something, and you need to know how much money you need to put aside each month to hit your goal!

TIP: Check the terms and conditions.

Yeah, yeah … but it’s important.

Make sure that you understand what you have to do to earn the interest – extra money. Some accounts have rules and if you don’t follow them, you don’t earn your money.

Check if you can withdraw during the month – there might be a limit on how much you can withdraw or you might not be able to make ANY withdrawals. For some accounts, if you withdraw money, you lose any interest you were going to earn that month.

Sometimes you will need to maintain a certain dollar amount in the account. Or you need to make a certain number of deposits in the account every month.

The details matter and the ‘extra’ money for pretty much doing nothing at all will put a smile on your face at the end of every month!