Interest

Updated 12 Mar 2026Content was accurate at the time of publication

Interest is the cost of borrowing money or the reward for lending or saving it — expressed as a percentage rate you pay or receive on a principal sum over time.

What is interest?

Interest is the price of using money. When you borrow, a lender charges interest to compensate for risk, time and lost opportunity. When you save or deposit money, an institution pays interest to reward you for allowing them to use your funds. Interest appears across common products such as mortgages, personal loans, credit cards, savings accounts and term deposits.

Lenders (banks, credit unions, non-bank lenders) and deposit takers calculate interest using a rate expressed per period — typically per annum (p.a.). That rate, combined with how often it is applied (compounding frequency) and any fees, determines the total cost of a loan or the total return on savings.

How interest is expressed

Interest rates are shown in several ways. Understanding each helps you compare offers accurately.

p.a. (per annum) means a yearly rate. For example, "5% p.a." means 5% over one year.

Nominal rate vs Effective rate: The nominal rate is the stated rate that does not account for compounding within the year. The effective rate (effective annual rate) reflects compounding and shows the true annual cost or return.

APR and comparison rate: APR (annual percentage rate) may be used as a standardised yearly rate; definitions vary by jurisdiction. The comparison rate combines the interest rate and certain fees into a single percentage to help compare loan offers.

Example: 12% nominal compounded monthly has a higher effective rate than 12% nominal compounded annually — that difference affects what you actually pay or earn.

Types of interest

Interest takes several forms — each affects outcomes differently.

Simple interest is calculated only on the original principal. It is common for short-term loans or some fee calculations.

Compound interest is interest on the principal plus accumulated interest. Frequency (monthly, daily, annually) matters. It drives faster growth for savings and faster cost growth for debt.

Fixed interest means the rate stays the same for a set term. Repayments are predictable; you may incur break costs if you exit early.

Variable interest means the rate can move with market conditions or lender policies; repayments may vary.

Application examples: Home loans often combine variable or fixed rates with amortisation. Savings accounts typically use compound interest; credit cards often compound daily.

How interest is calculated (formulas & examples)

Core formulas (written plainly for clarity):

Simple interest: I = P × r × t where I = interest, P = principal, r = annual rate (decimal), t = time in years.

Compound interest (future value): A = P × (1 + r / n)^(n × t) where A = amount after t years, n = compounding periods per year.

Standard loan repayment (monthly): R = P × [i × (1 + i)^N] / [(1 + i)^N - 1] where i = monthly rate (annual rate / 12), N = total number of payments.

Worked examples

Savings — compound interest (monthly)

Scenario: Deposit $1,000 AUD at 2.5% p.a., compounded monthly, for 5 years.

Inputs: P = 5,000, r = 0.025, n = 12, t = 5.

Calculation: A = 5,000 × (1 + 0.025 / 12)^(12 × 5). Monthly factor: 1 + 0.025/12 ≈ 1.0020833. Exponent: 60. A ≈ 5,000 × 1.1314 = 5,657.00 AUD.

Result: Your balance grows to about $1,657 AUD — $157 interest earned.

Loan — amortisation (monthly repayments)

Scenario: Borrow $10,000 AUD at 7.0% p.a., repay monthly over 5 years (60 months).

Inputs: P = 30,000, annual rate r = 0.07, monthly rate i = 0.07 / 12 ≈ 0.0058333, N = 60.

Calculation: R = 30,000 × [0.0058333 × (1 + 0.0058333)^60] / [(1 + 0.0058333)^60 - 1]. R ≈ $185.51 per month.

Total repaid: 585.51 × 60 ≈ $15,130.60 AUD. Interest paid: ≈ $1,130.60 AUD.

Credit card — daily compounding (illustrative)

Scenario: Card APR 20.0% p.a., interest applied daily on closing balance (365 days).

Daily rate ≈ 0.20 / 365 = 0.0005479. If average daily balance is $1,000 AUD for 30 days, interest ≈ 2,000 × [(1 + 0.0005479)^30 - 1] ≈ $13.24 AUD.

Key point: More frequent compounding increases cost compared with annual compounding at the same nominal rate.

Calculator tools

Useful calculators help you model scenarios and make faster decisions:

Compound interest calculator: Inputs principal, rate p.a., compounding frequency, years, and regular contributions. Outputs final balance, interest earned, and year-by-year breakdown.
Loan repayment calculator: Inputs loan amount, interest rate p.a., repayment frequency, term, and extra repayments. Outputs periodic repayment, total interest, and amortisation schedule.

Practical tip: use these calculators to model extra repayments, different terms and fee scenarios before you commit to a product.

How interest rates are set and what influences them

Interest rates offered to you reflect several layers:

Central bank cash rate: The Reserve Bank cash rate influences short-term funding costs and sets a benchmark for many variable retail rates.

Bank funding costs: Deposit levels, wholesale borrowing costs and market conditions.

Lender margins and product features: Credit risk, term, security and product costs determine margins added to funding costs.

Competition and regulation: Market competition and prudential regulation shape rates.

When the central bank raises or lowers the cash rate, variable loan and deposit rates often adjust. Fixed rates reflect market expectations for future cash rates plus lender margins.

Tax and reporting implications

Interest you earn (for example, on savings or term deposits) is generally assessable income. Keep records of interest statements and report interest income as required.

Borrowing interest may be deductible in certain circumstances (for income-producing investments) but not for personal expenses. For tax treatment questions or complex situations, consult a tax professional.

How to compare and reduce interest costs

Practical steps to compare and lower interest:

Compare like-for-like: Use effective rates and the comparison rate to include relevant fees.
Include fees and charges: Headline rates can be offset by establishment, ongoing or early exit fees.
Make extra repayments: Reducing principal sooner cuts total interest — test scenarios in a loan calculator.
Refinance and consolidate carefully: Combining higher-interest debts into a lower-rate loan can reduce costs but check fees and terms.
Fixed vs variable: Fixed rates lock payments and protect against rises; variable rates let you benefit from falls and may allow fee-free extra repayments.
Negotiate: Ask lenders for discounts or to match competitor rates.
Use independent tools: ASIC MoneySmart has calculators and comparison guides.

Common mistakes and misconceptions

Confusing APR/nominal rate with effective rate — this can understate true cost.
Ignoring compounding frequency — more frequent compounding increases effective cost/return.
Overlooking fees — headline rates don't show establishment, ongoing or early exit fees.
Treating minimum credit card payments as sufficient — this prolongs debt and increases interest dramatically.
Assuming fixed equals cheaper — fixed protects against rises but may carry higher initial rates or break costs.

FAQ

Is interest the same as APR?

Not always. APR can be a standardised measure that may include some fees; the effective rate shows true annual cost including compounding. Check your comparison rate for a fuller view.

How does compound interest affect savings?

Compound interest accelerates growth because you earn interest on prior interest. The longer money is invested and the more frequent the compounding, the larger the effect.

How is interest charged on home loans?

Home loans typically use daily or monthly interest calculations on the outstanding balance; repayments reduce principal and therefore future interest.

What is the fastest way to reduce interest on a loan?

Make extra repayments or increase repayment frequency to reduce principal sooner. Consider refinancing if you can get a materially lower effective rate after fees.

Do I need to declare interest I earn?

Yes. Interest earned is usually assessable income; retain statements and follow ATO guidance at ato.gov.au.

Are headline rates reliable for comparison?

Headline rates aren't enough. Use the effective rate and comparison rate to include compounding and fees.

Key takeaways

Understanding how interest works helps you make better borrowing and saving decisions. Interest is expressed and calculated in different ways — nominal, effective and comparison rates each tell a different story. By learning how compounding and fees affect your costs, comparing rates properly and making extra repayments when possible, you can reduce interest expense significantly.