What Are Interest Rates?

Interest rates might alternate between making you feel great and making you feel like you want to pull the covers over your head. You can divide interest rates into two types — investment returns or interest you accrue when you borrow money.   

You may want to pay super close attention to interest rates when you borrow. Why? Well, despite the fact that you might feel like you’re splitting hairs over a 2.25% interest rate and a 2.75% interest rate, but a slight difference in a tenth of a percent can make a major difference over the long term. 

Here’s what you need to know before you take out a loan or if you just want to eyeball interest rates a little more closely.

What Are Interest Rates? 

An interest rate is a percentage charged on the total amount you borrow or save. When you borrow money, the interest rate amounts to a percentage of the total amount of your loan. You must pay interest on the amount you borrow. 

APR and APY

You might notice that some interest rates have what’s called an annual percentage rate (APR) and an annual percentage yield (APY). APY indicates the rate at which your deposit account earns money. APR, the yearly interest plus any applicable fees, amounts to the annual cost of borrowing money. 

When you borrow, you want to pay attention to APR. APR gives you the “fullest” understanding of how much it costs to borrow money because the APR on a loan includes both the interest rate and the fees that the lender charges.

Types of Interest Rates

The nominal interest rate, the effective rate, and the real interest rate. The nominal interest of an investment or loan is simply the stated rate on which your interest payments get calculated.

Credit Card Interest Rates 

The average credit card interest rate in the U.S. amounts to 14.65%, according to data from the Federal Reserve.

You may assume you can make the minimum payment and avoid the fees that credit cards charge when you don’t make a payment on time. However, it can take years to pay down a credit card balance if you only make minimum payments.

Applying payments to your credit card in full every month offers you the largest benefit. However, pay as much as you can to get you out of debt more quickly.

Mortgage Interest Rates

Your lender takes a look at your three-digit FICO score and the three credit reports through Experian, Equifax and TransUnion. All of these list your credit history, and the information in your credit report makes up your FICO score. FICO scores range from 300 to a high of 850. The higher your score, the more likely you can qualify for a loan with a low interest rate. Lenders generally qualify a score of 740 as excellent.

You can expect to pay a higher interest rate and APR if you have a low credit score. Your interest rate and APR will be lower if you have a high credit score.

What else do lenders check? Your debt-to-income ratio (among other things). Your debt-to-income ratio (DTI), a measure of how much of your gross monthly income your total monthly debts use up, means that lenders want to make sure your DTI is not too large compared to your monthly income. Lenders like to see your DTI at no more than 43% of your gross monthly income. Your lender might boost your interest rate and increase your APR if you have a higher DTI.

Student Loan Interest Rates

Experian’s latest data shows a record high in student loan balances in 2020. Student loan debt increased only about 6% per year from 2015 to 2019, but since the onset of the pandemic, that growth has doubled.

In the past year, the overall student loan balance increased by 12%, Experian found. Total U.S. outstanding student loan debt is now over $1.57 trillion, a record high and $166 billion increase year over year.

Student loan interest rates for federal loans typically amount to less than private student loan interest rates. (In other words, you want to tackle federal student loans first.)

Check out the following table to learn the fixed interest rates for new Direct Loans first disbursed on or after July 1, 2020 and before July 1, 2021. 

Loan Type

Borrower Type

Fixed Interest Rate

Direct Subsidized Loans and Direct Unsubsidized Loans

Undergraduates

2.75%

Direct Unsubsidized Loans

Graduate or Professional Students

4.30%

Direct PLUS Loans

Parents of Undergraduate Students or Professional or Graduate Students

5.30%

Auto Loans

U.S. auto loan interest rates average 5.27% on 60-month loans. Rates vary based on credit score, length of the loan, car age and other factors relevant to how much risk you present to a lender when you borrow for an auto loan. The annual percentage rate (APR) for auto loans ranges from 3% to 10%.

Auto loan rates have hit historic lows due to a low interest rate environment. Loans from auto finance companies usually carry lower rates than loans from commercial banks. In other words, Ford Finance, Chrysler Capital, GM Financial provide loans for consumers and let individuals buy automobiles at lower rates.

CDs and Savings Accounts

When you have short-term needs, such as paying for a vacation or making a car down payment or establishing a liquid emergency fund, you can put your money into a CD or savings account. 

The average interest rate for U.S. savings account was only 0.05% for a balance below $100,000 in January 2021, according to the Federal Deposit Insurance Corp. (FDIC). A high-yield savings account might offer you a little more — but not much. 

Certificates of deposit (CDs), deposit accounts available from banks and credit unions, allow you to withdraw money from from them after a certain period of time expires, such as one, two or 10 years. You cannot withdraw money from a CD without paying a financial penalty.

However, CDs typically provide higher interest rates than savings accounts. As of January 21, 2021, the average APY for a six-month CD with a balance below $100,000 was 0.10% and the average APY for a 60-month CD was 0.32%. 

Once the CD’s term ends, you can withdraw the money or roll it over to a new CD. Before you choose a CD, take a look at the APY, the penalty for early withdrawal and whether you could lose money if you make a withdrawal before the CD reaches its “maturity” date. Don’t forget to determine whether you need the money or not. If you need to quickly access the money instead of letting it sit in the CD, you might want to look into a different option.

Interest Debt 

Interest rates can put you in the hole, particularly with credit card debt. Credit cards let you spend more than you make. Paying everything with cash can make a difference because you can see what’s happening with your money. The size of your paycheck limits how much you can spend.

You May Want to Get a Lower Interest Rate 

You may want to find out if your credit card issuers will reduce your interest rate. Call your creditors — whether your mortgage lender or credit card issuer — and ask for a lower interest rate. Note that if your interest rate increased because you were 60 days late on a credit card payment, the credit card issuer has to lower your rate after six consecutive timely payments.

Hire a Debt Relief Organization if You Find Yourself Stuck

Stuck in a huge cycle of paying off big balances that have high APRs? It can wind up feeling really frustrating and scary, and as a result, it can take years to pay off high-interest accounts.

Credit counseling services have trained staff who can walk you through what you need to do to pay off your credit cards and build good credit scores. 

Are You Getting the Best Interest Rates?

Interest rates influence a lot, including the cost of borrowing, how much you can personally save and can even affect how soon you retire! Interest rates also help determine the strength or weakness of the economy at large. 

You may have seen interest from your savings accounts CDs, and other investments change in the wake of the pandemic. Comparing and contrasting interest rates for all of your purchases can save you money. If you know you can get a lower student loan interest rate from one lender compared to another, make sure you get the one that fits your needs best. 

Many individuals don’t take the time to compare interest rates when they could end up saving thousands of dollars over the life of the loan. Again, a 2.25% interest rate compared to a 2.75% interest rate makes a difference!

Finally, don’t forget to save for college with a tax-advantaged investment account for kids with UNest — it offers the best kind of returns!

Invest in your kids’ future goals — help them save for an education, first car, house, pay for a wedding or even to help them feel more financially secure as an adult!

Melissa Brock spent 12 years in college admission and is the founder of College Money Tips and the Money editor at Benzinga. She writes tons of financial content and loves helping families navigate the college search process. Check out her essential timeline and checklist for the college search!