What is interest?

Interest is quoted as a rate per period, almost always per annum (p.a.), meaning a yearly rate. The nominal rate is the stated rate and takes no account of compounding within the year. The effective annual rate reflects compounding, so the same nominal rate compounded monthly produces a higher effective rate than one compounded annually, and that difference changes what you actually pay or earn.

Under the National Credit Code the annual percentage rate (APR) is the interest rate disclosed on a credit contract, and fees are not in it. The Australian figure that adds most compulsory fees is the comparison rate, which is what puts loan offers on the same basis. Headline rates alone are not enough: establishment, ongoing and early exit fees can offset a low rate.

Simple interest is calculated only on the original principal (I = P × r × t, with r the annual rate as a decimal and t the time in years) and is common on short-term loans. Compound interest is charged on the principal plus accumulated interest (A = P(1 + r/n)^(nt), with n compounding periods a year), so frequency matters: it speeds up growth for savings and cost for debt. Fixed interest holds the rate for a set term, giving predictable repayments but possible break costs if you exit early; variable interest moves with market conditions or lender policy, so repayments can change.

A standard loan repayment is R = P × [i(1 + i)^N] / [(1 + i)^N - 1], where i is the monthly rate and N the number of payments. Home loans typically calculate interest daily or monthly on the outstanding balance, savings accounts use compound interest, and credit cards often compound daily.

The rate on a loan or deposit reflects several layers: the RBA cash rate, which influences short-term funding costs and benchmarks many variable retail rates; the lender's funding costs from deposits and wholesale borrowing; the margin it adds for credit risk, term, security and product costs; and competition and prudential regulation. When the cash rate moves, variable loan and deposit rates often follow, while fixed rates reflect market expectations for future cash rates plus lender margins.

Interest you earn on savings or term deposits is generally assessable income, so keep your statements. Interest on borrowing may be deductible when the money is used for income-producing purposes but not for personal expenses; check with your accountant or the ATO. What changes the total cost is the effective rate, the fees, how quickly the principal comes down, and whether a cheaper loan is available on refinance.