Borrowing and credit
What is an interest rate?
Quick definition: An interest rate is the percentage used to calculate interest paid on savings or charged on borrowing over a stated period.
At a glance
- Savings rates describe interest earned.
- Borrowing rates describe interest charged.
- Rates can be fixed or variable.
- The headline rate may not show all fees or product conditions.
Explain it simply
An interest rate is a percentage used to work out interest. If you save money, interest is extra money the bank may pay you. If you borrow money, interest is part of the cost you may pay back. A higher savings rate can mean more interest earned, while a higher borrowing rate can mean borrowing costs more. Rates can change unless they are fixed for a period, so it is important to read the account or loan terms.
Student explanation
Interest rates help compare savings and borrowing products, but they need context. A savings rate may be shown as gross or AER, while borrowing may be shown as APR, EAR or another product-specific rate. The period matters: a rate described as annual is not the same as a monthly charge. Fixed rates stay the same for an agreed period, while variable rates can change. Students should also understand inflation because the real value of savings depends on how prices change as well as the interest paid.
Professional explanation
An interest rate is the stated percentage used to calculate interest accrual on a balance over time. In retail banking it appears across deposits, overdrafts, loans, mortgages and credit cards, but calculation methods, compounding, fees and disclosure rules differ by product. Rates may be nominal, effective, fixed, variable, tracker-based or promotional. Provider pricing is influenced by funding costs, risk, competition, Bank Rate expectations, capital considerations and product strategy. Customer communications must avoid implying equivalence between rates such as APR, EAR and AER where they measure different things.
UK example
A savings account paying a variable interest rate may pay more or less interest later if the provider changes the rate.
Why it matters
Interest rates affect the cost of borrowing and the return on saving, so understanding the type of rate is essential for comparisons.
Common misunderstanding
One interest rate cannot always be compared directly with another unless the calculation basis, fees and period are understood.