How Interest Rates Work on Loans and Savings
What an interest rate measures, the difference between APR and APY, and why compounding makes the same rate cost more on a loan and earn more in savings over time.
Key points
- An interest rate is the price of money for a year. You pay it when you borrow and earn it when you save, and the same arithmetic works in both directions.
- On loans, compare the APR, which adds certain fees to the rate. On savings, compare the APY, which adds the effect of compounding.
- Compounding means interest is charged or paid on earlier interest. Over years it makes a large difference in both directions.
- The Federal Reserve sets a target for an overnight bank rate, not your rate. Your rate depends on the product, the lender and your credit.
An interest rate is the price of using money for a year, written as a percentage of the amount. When you borrow, you pay it; when you save, the bank pays it to you. The arithmetic is the same in both directions, which is why the habits that make borrowing expensive are the same ones that make saving work.
What a rate measures
Interest is charged on the principalThe amount you borrowed or deposited, before any interest. Loan payments reduce it; interest is calculated on what is left of it.: the amount borrowed, or the amount deposited. A 7% rate on $10,000 means about $700 of interest over a year if nothing is repaid and nothing compounds. Two things change that simple picture: fees, which make borrowing cost more than the rate suggests, and compounding, which makes both debts and savings grow faster than the rate suggests.
That is why the law requires two different headline numbers. On loans, lenders must disclose the APRAnnual percentage rate: the yearly cost of credit, including the interest rate and certain fees. It is the number lenders must disclose so loans can be compared., which Regulation Z defines as a measure of the cost of credit, expressed as a yearly rate; it includes finance charges such as origination fees and points. On deposits, banks must disclose the APYAnnual percentage yield: what a deposit earns in a year once compounding is included. It is the number banks must disclose on savings accounts and CDs., which Regulation DD bases on the interest rate and the frequency of compounding. The plain interest rate, by the same rule, does not reflect compounding.
Where rates come from
The Federal Reserve does not set the rate on your card, your mortgage or your savings account. It sets a target range for the federal funds rate, the rate banks charge each other for overnight loans. On September 16, 2026 it raised that range by a quarter point, to 3.75% to 4.00%.
The Fed explains that changes in its target influence other interest rates that in turn affect borrowing costs for households and businesses. Rates on floating-rate loans react quickly; longer-term rates such as mortgages depend more on what markets expect over years than on the current target. Lenders then add their own margin, based on the product, their costs and your credit.
| Rate | Figure | Publisher and date |
|---|---|---|
| Federal funds target range | 3.75% to 4.00% | Federal Reserve, decision of September 16, 2026 |
| Bank prime loan rate | 7.00% | Federal Reserve H.15, for September 22, 2026 |
| 30-year fixed mortgage, weekly average | 7.03% | Freddie Mac survey, September 24, 2026 |
| 60-month new car loan at banks | 7.14% APR | Federal Reserve G.19, second quarter of 2026 |
| 24-month personal loan at banks | 11.86% APR | Federal Reserve G.19, second quarter of 2026 |
| Credit card accounts charged interest | 22.15% APR | Federal Reserve G.19, second quarter of 2026 |
| Savings, national average | 0.37% | FDIC, as of September 21, 2026 |
| 12-month CD, national average | 1.73% | FDIC, as of September 21, 2026 |
The G.19 figures were collected before the September 2026 rate decision. Freddie Mac's survey is updated weekly and the FDIC's monthly.
Two figures in that table show how wide the spread is. In the same weeks, the FDIC's national average savings rate was 0.37% while the Fed's measure of card accounts that were charged interest stood at 22.15%. Marcus by Goldman Sachs, for one, listed its online savings account at 3.50% APY as of September 24, 2026. Where you keep money and where you borrow it matter more than any single rate decision.
Simple and compound interest
With simple interest, you earn or pay interest only on the principal. With compound interestInterest paid on the principal and on interest already added to it. The more often it compounds, the faster the balance grows., which Investor.gov defines as interest on principal and on accumulated interest, each period's interest joins the balance and earns or costs interest itself.
| Year | Simple interest | Compounded yearly |
|---|---|---|
| 1 | $1,050.00 | $1,050.00 |
| 2 | $1,100.00 | $1,102.50 |
| 5 | $1,250.00 | $1,276.28 |
| 10 | $1,500.00 | $1,628.89 |
Simple interest is paid only on the original $1,000. Compound interest is paid on the growing balance, so the gap widens every year.
The difference is small in the first years and large later. It works for you in a savings account left alone and against you on a debt left unpaid. Investor.gov offers a compound interest calculator to try your own numbers, and describes a quick estimate, the Rule of 72: divide 72 by the annual rate to see roughly how many years money takes to double.
Compounding frequency matters too. A savings account paying 3.44% compounded monthly works out to an APY of about 3.50%, our own calculation with the formula in Regulation DD. That is why banks quote APY: it lets you compare accounts that compound daily, monthly or quarterly on the same basis. Regulation DD gives its own example: an account that pays $61.68 of interest in a 365-day year on a $1,000 deposit has an APY of 6.17%. The rule also requires the account disclosure to show both the "annual percentage yield" and the "interest rate", using those exact terms, so you can always see both numbers.
On the borrowing side, the CFPB makes the mirror point for mortgages: the APR reflects the interest rate plus points, broker fees and other charges, and is usually higher than the interest rate. If a lender quotes you only the rate, ask for the APR.
How interest works on a loan
Most installment loans, such as car loans and personal loans, use simple interest on the remaining balance. The CFPB notes that this kind of simple interest is far more common on auto loans than precomputed interest, and it is calculated on the outstanding balance daily or monthly. Payments follow an amortizationRepaying a loan in scheduled payments that cover the interest due and part of the principal, so the balance reaches zero at the end of the term. schedule: the payment stays the same, but its split changes.
| Payment | Interest | Principal |
|---|---|---|
| 1st | $119.00 | $278.35 |
| 30th | $66.75 | $330.60 |
| 60th | $2.35 | $395.00 |
| All 60 | $3,840.78 | $20,000.00 |
Simple-interest loan with monthly interest on the remaining balance, no fees. Paying extra toward principal early reduces all later interest.
Early payments are mostly interest, because the balance is at its highest. As the CFPB puts it, more of your payment goes toward interest at the beginning of the term. That is also why extra payments made early save the most: every dollar of principal repaid in the first year stops accruing interest for the rest of the term. Check whether the loan has a prepayment penalty, and tell the lender to apply extra money to principal.
A fixed rate stays the same for the life of the loan. A variable or adjustable rate can change: for mortgages, the CFPB explains that with an adjustable rate the interest rate may go up or down. The contract says which index it follows, how often it can change and whether there is a cap.
How interest works on a credit card
Cards work differently. Many issuers, the CFPB explains, calculate interest daily based on the average daily balance, using a daily periodic rate. As our own arithmetic, a 22.15% APR divided by 365 is about 0.061% a day, which on an average balance of $1,000 over a 30-day cycle comes to roughly $18.21 of interest. Next month, if the balance isn't paid, interest is charged on that interest too.
Most cards charge no interest on purchases if you pay the full statement balance by the due date. Once you carry a balance, the daily arithmetic takes over.
How interest works on savings
On deposits the same compounding works in your favor, but the rates are usually lower than on borrowing, and often variable. Many savings and money market rates are variable, and the account disclosure says how they can change. A certificate of deposit fixes the rate for a term in exchange for a penalty if you withdraw early. The FDIC's national average for a 12-month CD was 1.73% as of September 21, 2026, and individual banks publish rates well above it.
Inflation is the other side of savings. Series I savings bonds from the Treasury combine a fixed rate with an inflation rate; bonds issued from May 1 to October 31, 2026 earn a composite rate of 4.26%, made of a 0.90% fixed rate and a 1.67% semiannual inflation rate. The Treasury resets the inflation part every six months.
What to consider before choosing
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Is the rate fixed or variable?
A fixed rate stays the same for the whole term. A variable rate follows an index and can move in either direction, so the payment on a loan, or the yield on savings, can change after you sign.
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Are you comparing the same measure?
Put APR next to APR for loans and APY next to APY for savings. A bare interest rate leaves out fees on a loan and compounding on a deposit.
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Over what period does the rate apply?
Intro rates on cards and promotional savings rates last for a set time. Ask what the rate becomes afterward and when.
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What does the whole term cost or earn in dollars?
A percentage is easy to misread. The total interest over the term, in dollars, is the number that tells you what a loan really costs or what a deposit really earns.
Questions to ask before you sign
Ask the lender or the bank these questions, and look for the answers in the loan disclosure or the account's Truth in Savings disclosure:
- What is the APR (for a loan) or the APY (for a deposit), and what is the plain interest rate behind it?
- Is the rate fixed or variable? If variable, which index does it follow, how often can it change and is there a cap?
- Which fees are included in the APR, and are there fees that aren't?
- How is interest calculated: daily or monthly, on what balance?
- What is the total interest over the whole term, in dollars?
- Is there a penalty for paying off early, or for withdrawing a deposit early?
- For a promotional rate: how long does it last, and what rate applies afterward?
Common questions
Why is the APR on my loan higher than the interest rate?
Because the APR includes certain fees, such as an origination fee or points, spread over the term. If a loan has no such fees, the two numbers can be the same.
Does a Federal Reserve rate change affect my existing loan?
Not if its rate is fixed. The Fed notes that its changes are reflected quickly in rates on floating-rate loans, so a variable-rate card or loan can move; the contract says which index it follows and when the change takes effect.
How do I estimate how long money takes to double?
The SEC's Investor.gov describes the Rule of 72: divide 72 by the annual rate. At 9% a year, money doubles in about 8 years. It is an estimate, not an exact figure.
Is interest on savings taxable?
Generally yes: the IRS treats interest credited to your account as taxable income for the year it becomes available to you, even if you don't withdraw it.
What is a prepayment penalty?
A fee some lenders charge if you pay off all or part of a loan early. The CFPB, writing about mortgages, notes that it doesn't normally apply to small extra principal payments, but advises checking with the lender. Ask before you sign if you might repay early.