How does interest work?
Chances are, if you have opened a savings account or applied for a loan, you may have come across the term “interest.”
What is interest?
Interest can have two different concepts when it comes to the banking world. Regarding lending, it is the price you pay to borrow money. But when it comes to deposit accounts, it represents the amount an account holder earns on the balance in the account if it is an interest-bearing account.
Break it down this way… with a loan, you typically will pay more money than what you borrow. With an interest-bearing deposit account, you will earn money each month.
Paying for interest
When you borrow money (“principal”), the interest is the cost of borrowing the principal. Examples include, but are not limited to the following:
- Installment debt: Loans such as mortgages, auto loans, and some student loans include the interest in the monthly payment. You will pay down your loan over a specified loan term as agreed upon with your lender. A portion of the payment will be applied to the interest due, and the remainder of the payment is applied to the principal.
- Revolving debt: Revolving debts, such as lines of credit and credit cards allow you to borrow on an “as needed” basis, up to a maximum of your credit limit. You may borrow month to month and will make monthly payments.
- Additional costs: The Annual Percentage Rate (APR) represents the price you pay to borrow money. The APR is a number that’s used to show how much interest will be paid based on the outstanding principal. The higher the APR, the more you will pay over the life of the loan. The APR provides a consistent basis for presenting annual interest rate information in order to prevent companies from misleading customers.
Earning interest
You can earn interest on money you deposit in an interest-bearing savings account, checking account, and certificates of deposit. When you earn interest on one of these accounts, it is the money that a bank pays you to keep your money in one of their accounts. Interest earned can be calculated daily, monthly, or quarterly.
- Interest vs. Compound Interest: Interest is the payment to an account and is calculated by applying a periodic rate to the balance. As you earn interest during the period, and if you leave the existing balance and interest deposited in the account, you will earn interest on top of the accumulated interest earned during the next period. This is known as compounding interest.
- Annual Percentage Yield (APY): APY measures the total amount of interest you will earn on a deposit in a year, based on the interest rate and the frequency of compounding.
Questions about interest rates
If you would like to learn more about interest rates for deposit accounts and loans, visit adkbank.com or your local branch for full details.
Previous blogs regarding APR and APY: Annual percentage rate (APR) and annual percentage yield (APY).
The information in this article was obtained from various sources not associated with Adirondack Bank. While we believe it to be reliable and accurate, we do not warrant the accuracy or reliability of the information. Adirondack Bank is not responsible for, and does not endorse or approve, either implicitly or explicitly, the information provided or the content of any third-party sites that might be hyperlinked from this page. The information is not intended to replace manuals, instructions or information provided by a manufacturer or the advice of a qualified professional, or to affect coverage under any applicable insurance policy. These suggestions are not a complete list of every loss control measure. Adirondack Bank makes no guarantees of results from use of this information.
