What Are Interest Rates & How Do They Work?

Interest rates affect almost every part of your financial life — from how much your savings can earn to how much you repay on a loan. It’s common for Australians to search for terms like “what is an interest rate” or “what is a good interest rate” because the topic can feel complex at first.

This guide explains what interest rates mean, how they’re determined, how they apply to saving and borrowing, and why even small changes can have a noticeable impact over time. It also explores different types of interest rates and how they apply to personal loans, helping you build your financial knowledge and confidence — so you can compare options more clearly and understand the trade-offs before you make decisions.

What is an interest rate?

An interest rate is the cost of borrowing money or the return you receive for saving money. It’s usually shown as a percentage of the amount borrowed or saved.

Interest rate definition

Interest rates represent:

• For borrowers: the cost of using money provided by a lender
• For savers: the return paid by a financial institution for keeping money in an account

This is the basic interest rate meaning. Interest is commonly expressed as an annual percentage rate (APR), which helps show the yearly cost of borrowing (including interest and, in many cases, standard fees).

Interest rates in Australia

Interest rates in Australia are influenced by the Reserve Bank of Australia (RBA), which sets the official cash rate. When the RBA changes this rate, lenders may adjust their interest rates in response.

To learn more about different rate types, see:
https://www.credit24.com.au/blog/what-is-a-variable-interest-rate
https://www.credit24.com.au/blog/what-is-a-fixed-interest-rate

How do interest rates work?

Interest rates work by applying a percentage charge (or return) to the amount of money borrowed or saved.

How lenders determine interest rates

Lenders set interest rates based on a range of factors, including:

• The RBA cash rate
• Cost of funding
• Market competition
• Borrower risk profile
• Loan type (secured or unsecured)
• Economic conditions

This is why interest rates can vary between lenders and products, and why the “same” loan amount can cost different people different amounts depending on the product features and risk assessment.

How interest is applied

• For loans: interest is added to your repayments over time.
• For savings: interest is added to your account balance, allowing your money to grow.

Time value of money

Interest exists because money available today generally has more value than the same amount in the future, due to factors like inflation and opportunity cost.

Simple interest vs. compound interest

Understanding how interest is calculated can help you better assess costs and returns.

Simple interest

Calculated only on the original balance.

Example:
$10,000 at 5% per year for 5 years
Interest = $10,000 × 0.05 × 5 = $2,500

Compound interest

Calculated on the original amount plus previously earned interest.

Example:
$10,000 at 5% per year for 5 years, compounded annually
Interest ≈ $2,833.59

Which products use which?

• Simple interest: many standard personal loans and some home loans
• Compound interest: savings accounts, term deposits, and some credit products

Compound interest can benefit savers over time. For borrowers, compounding may increase costs when interest is charged on an outstanding balance that isn’t being reduced (for example, when only small repayments are made).

Fixed vs variable interest rates

Fixed interest rates

Remain the same for a set period.

• Pros: predictable repayments, easier budgeting
• Cons: less flexibility if market rates decrease

Variable interest rates

Can change over time based on lender decisions or movements in the RBA cash rate.

• Pros: may decrease if rates fall
• Cons: repayments may increase

More detail here:
https://www.credit24.com.au/blog/what-is-a-fixed-interest-rate
https://www.credit24.com.au/blog/what-is-a-variable-interest-rate

Other types of interest rates

Tiered interest rates

Different rates apply once balances pass certain thresholds.

Banded interest rates

Different portions of a balance are charged or earn different rates.

Comparison rates

Include the interest rate plus most fees to help show the overall cost of a loan. A comparison rate can be useful when comparing similar products, but it may not include every fee or reflect every feature.

APR (Annual Percentage Rate)

Shows the yearly cost of borrowing, including interest and standard fees.

APY (Annual Percentage Yield)

Used for savings products and reflects the effect of compounding.

How interest rates are determined

The RBA’s role

The RBA sets the cash rate, which influences how much it costs banks to borrow money. This can affect personal loans, home loans, savings accounts, and business lending rates.

Other factors influencing interest rates

• Inflation levels
• Employment conditions
• Economic growth
• Borrower risk (credit history, income, existing debts)
• Loan type and term length
• Whether the loan is secured

Why do interest rates matter for your finances?

Even small differences in interest rates can affect your overall costs or returns. Understanding what drives rates and how they’re applied can help you ask better questions, compare options more effectively, and avoid surprises.

Impact on loans (example)

Loan amount: $20,000
Loan term: 3 years
Rate difference: 12% vs 14%

A relatively small rate change can increase the total interest paid over the life of the loan. The exact difference depends on factors like repayment structure and fees, so comparing the full cost (not just the headline rate) can be helpful.

Impact on savings

Higher interest rates can help savings grow faster, particularly when interest compounds over time. However, the final outcome can also depend on account conditions, how often interest is paid, and whether any bonus rate criteria apply.

Impact on purchasing power

When interest rates rise, loan repayments may increase, which can affect household budgets and spending flexibility.

How interest rates affect the broader economy

Interest rates are one of the RBA’s main tools for managing economic conditions.

When rates rise

• Borrowing may become more expensive
• Spending may slow
• Inflation may ease
• Businesses may become more cautious

When rates fall

• Borrowing may become more accessible
• Spending may increase
• Economic activity may grow

Interest rates also influence employment, wages, and investment decisions.

Interest rates and different financial products

Home loans

Often have lower rates, but longer terms can mean more interest paid overall.

Personal loans

Rates vary based on security, credit profile, and loan size.

Credit cards

Typically have higher interest rates, especially if balances are not paid in full.
More detail here:
https://www.credit24.com.au/blog/how-does-credit-card-interest-work

Savings accounts & term deposits

Earn interest rather than incur it. Term deposits usually offer fixed rates for a set period.

Tips for understanding and comparing interest rates

Because the CMS can’t display tables, here’s a simple checklist format you can use.

For loans (comparison checklist)

• Look at the rate type: fixed, variable, or introductory
• Check the comparison rate (if provided): to understand a broader cost view
• Review fees and charges: establishment, monthly, late payment fees (where applicable)
• Consider the term length: shorter terms may reduce total interest paid, but repayments may be higher
• Think about repayment frequency: weekly/fortnightly/monthly can change how quickly the balance reduces
• Understand features and limits: redraw, extra repayments, repayment flexibility (if offered)
• Review your credit position: your credit history and existing debts can influence eligibility and the rate offered

Helpful resource:
https://www.credit24.com.au/blog/credit-score-for-personal-loan

For savings (comparison checklist)

• Compare ongoing vs bonus rates: and how easy it is to meet bonus conditions
• Check how interest is calculated and paid: daily/monthly and any minimum balance requirements
• Review fees and access rules: account-keeping fees, withdrawal limits, notice periods
• Re-check periodically: rates and conditions can change over time

Need a loan now between $500 and $10,000? Meet Credit24

If you’re comparing personal loan options, it can help to look for clarity on costs, repayment structure, and how funds are delivered.

Credit24 offers personal loans with fixed interest rates, which may help make repayments more predictable over the life of the loan. Fixed repayments may assist with budgeting and financial planning.

Key features include:

• Fixed interest rate and fixed repayments
• Flexible loan use
• Transparent fees and charges
• Online application process
• Assessment times vary
• Funds sent via OSKO if approved
• No early repayment fees

Apply now: https://www.credit24.com.au/au/apply/login

FAQs about interest rates

What’s the difference between an interest rate and an APR?

An interest rate is the percentage charged on the loan amount. APR includes the interest rate plus most standard fees, providing a broader view of the yearly cost.

How often do interest rates change in Australia?

The RBA reviews the cash rate regularly, usually monthly. Lenders may adjust their rates at different times based on market conditions.

How can I estimate interest on a loan?

Simple interest can be estimated using:
interest = principal × rate × time
Online calculators can also help estimate repayments.

Will my interest rate change if the RBA changes the cash rate?

Variable-rate loans may change if lenders adjust their rates. Fixed-rate loans generally remain the same for the fixed period.

How do interest rates affect credit card debt?

Higher rates can increase the cost of carrying a balance over time, especially if repayments are limited to minimum amounts. More detail here:
https://www.credit24.com.au/blog/how-does-credit-card-interest-work

What is a good interest rate for a personal loan in Australia?

A suitable rate depends on factors such as your credit profile, loan amount, loan term, and the lender’s criteria. Comparing the total cost (including fees and charges) can help you understand which option best fits your situation.

Disclaimer

IPF Digital Australia Pty Ltd, trading as Credit24, ABN 59 130 894 405. Australian Credit Licence 422839. The information in this article is general in nature and does not consider your objectives, financial situation, or needs. Lending criteria, fees, and charges apply. For product details, eligibility requirements, and full terms and conditions, visit www.credit24.com.au.