Interpreting Interest Rates

Interest rates can be a tricky subject because they require different considerations depending on whether you’re paying back a loan or earning on your savings. When you take out a loan or carry a credit card balance from month to month, you’re using borrowed money, so in return, you pay the lender back with interest. Therefore, when you consider this type of interest, you try to find a low interest rate. On the other hand, when you lend your money to a financial institution by depositing it in a savings account, money market account or Certificate of Deposit (CD), that institution pays you interest. In that case, look for higher interest rates.

When you’re checking out interest rates, there are some key words you may want to keep in mind that will help you better understand what those numbers mean:

Annual Percentage Rate (APR)
The APR is the interest rate that you are paying on your loan. You’ve probably heard this term on car commercials, in which the APR is the interest rate on a particular auto loan. The annual percentage rate you pay generally varies based on your credit history and the details of your repayment.
Annual Percentage Yield (APY)
When you earn interest on savings or investment accounts, the APR is the determined amount your deposit will earn, but the annual percentage yield (APY) is the actual amount you will receive. That’s because the APY takes interest compounding into account. While the two numbers often look just alike, they may change with large deposits or a high compounding frequency.
When interest compounds on your savings account or CD, it means that interest is being earned on the entire balance which includes interest amounts earned in previous time periods. For example, if you deposit $10,000 in an account and you are earning a 1% interest rate, the APR would reflect $100 for 12 months. During the first month, you’ll receive $8.33 ($100÷12 months). The next month, your account will earn interest on your new balance of $10,008.33.
Variable Interest Rate
An interest rate on a loan or savings account will either be fixed or variable. A fixed interest rate will stay the same throughout the entire loan or deposit term, but a variable interest rate may change periodically based on factors such as your changing credit history or the economy.
In a credit union, we call the interest you earn on your savings account dividends. So if you have a one-year Certificate of Deposit (CD) which earns $100 in interest for a total value of $1,100 when the term is over, your dividends are $100.
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