Interest: the price of borrowing, and the reward for saving

Interest is the cost of borrowing money, or the reward for saving it. Here’s how it works, and why the difference between a 1% and a 5% rate matters far more than it sounds.

What is the interest?

Interest is the amount charged for borrowing money, or the amount earned for saving or lending it, typically expressed as a percentage rate applied over a specific period. On a loan, interest is the primary cost of borrowing beyond the amount originally received. On a savings account, interest is what the bank pays for keeping money with them. The same underlying concept works in opposite directions depending on which side of the transaction someone is on: a borrower wants a lower rate, while a saver wants a higher one.

How interest affects what you pay or earn

Two loans or accounts with the same stated interest rate can still result in very different outcomes, depending on the details:

• Simple interest is calculated only on the original amount. This is more straightforward and predictable to calculate.

• Compound interest is calculated on the original amount plus any interest already accumulated. This means cost or return can grow faster than simple interest would suggest, especially over a longer period. The CFPB explains this⁠(opens in new window) as earning interest on both the money saved and the interest already earned.

• The stated interest rate isn’t the same as the APR⁠(opens in new window). The APR includes additional fees on top of the interest rate, making it a more complete measure of a loan’s true cost.

Why a small rate difference matters more than it seems

The gap between a 1% and a 5% rate looks small written down, but compounding stretches that gap out considerably over time. Saving $10,000 at 1% compounded annually for 20 years grows to about $12,200. The same $10,000 at 5% compounded annually for the same 20 years grows to roughly $26,500, more than double, even though the rate difference is only 4 percentage points. The same logic applies in reverse to debt: a rate that looks only slightly higher on a loan can mean paying meaningfully more in total interest the longer that balance is carried.

Interest in everyday terms

Understanding the difference between APR and APY⁠(opens in new window) is a practical extension of understanding interest generally, since APY reflects compound interest earned on savings, while APR reflects the cost of borrowing including fees. Knowing which term applies to which side of a person’s finances, saving versus borrowing, helps in interpreting the numbers correctly rather than assuming the two are interchangeable.

What interest means for newcomers and immigrants

For someone new to a country’s financial system, interest terminology can be confusing, especially when different products use “interest rate,” “APR,” and “APY” seemingly interchangeably in casual conversation, even though they mean different things. Taking the time to understand which term applies to a specific product, and whether interest compounds, helps in making more informed decisions when opening new accounts and credit lines.

Someone without an established credit history yet may also be offered a higher interest rate than someone with a longer track record, simply because the lender has less information to assess risk against. This is worth factoring into the math directly: a seemingly modest difference in the rate offered can compound into a meaningfully larger cost over the life of a loan, which is part of why comparing rates across a few lenders, rather than accepting the first offer, matters even more for someone building credit from scratch. On the savings side, the same principle works differently: even a small amount saved consistently, at a modest rate, benefits from the same compounding effect over years, which is a genuinely encouraging fact for someone starting to build savings from very little.

First steps for understanding interest on your accounts

• Checking whether an account uses simple or compound interest is worth doing early, since this significantly affects the actual cost or return.

• Looking for the APR, not just the interest rate, on any credit product shows the fuller cost picture.

• Asking how often interest compounds on a savings account matters too, since more frequent compounding generally results in a higher effective return.

In Summary

Interest is a simple concept with genuinely complex real-world effects, depending on whether it’s simple or compounding, and how frequently it’s applied. Understanding these details, rather than just the headline rate, helps in evaluating both borrowing costs and savings returns accurately. Understand your options and check the specific interest terms before opening any new account or credit line.

This publication is provided for general information purposes only and is not intended to cover all aspects of the topics discussed herein. This publication is not a substitute for seeking advice from an applicable specialist or professional. The content in this publication does not constitute legal, tax, or other professional advice from Remitly or any of its affiliates and should not be relied upon as such. While we strive to keep our posts up to date and accurate, we cannot represent, warrant, or otherwise guarantee that the content is accurate, complete, or up to date.