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Interesting interest

April 19, 2024
July 20, 2020

Have you ever looked at the interest rate and not actually really known what it meant? Don’t worry, we’re here to make interest interesting. Sort of.

Why should I care about interest?

The simple reason: It’s the money you pay on a loan or the money you make on your savings. If you’re a borrower, the interest you pay a bank is about the second biggest thing you’ll ever buy (behind your home).

Interest payments are a big source of revenue for banks and they use that money to do more business.

Where they put that money matters. At Bank Australia, we only use money to do good, not harm. You can read more about clean money here.

So, if interest is the second biggest thing you'll pay after your home, you need to know how much you’re paying or earning and how to compare it to other rates. Being able to compare interest rates means you can find the better deal for you.

If you want to answer the questions “How much am I paying for my home loan?” or “How much am I earning on my savings balance?”, then read on!

How does it work?

The amount of interest you pay on your loan or earn on your savings depends on your interest rate.
Your interest rate is a percentage. We apply that percentage to the balance of your loan or your savings.

If you have $1000 in savings, and the interest rate on the savings account is 1% per annum (that’s a fun legal word we use to mean ‘year’ ), you’ll have $1010 at the end of the year. That’s because 0.01 (1%) x $1000 is $10.

But here’s where it gets fun: you can earn interest on your interest.

That’s called compound interest

Compound interest is when you earn interest on top of the interest you’ve already earned.

So after one year of your $1000 in savings, you’ve earned 1% interest and you have $1010.

But at the end of year two, you’ll earn 1% interest on your $1010. You now have $1020.10 because you earned $10 and 10c in interest in year two .

To bring in a bit of maths, it’s:

Year 1 = 0.01 (1%) x $1000 = $10 resulting in $1010.00

Year 2 = 0.01 (1%) x your new savings of $1010 = $10.10 resulting in $1020.10 all up!

That’s the compound interest and it will keep going and going as long as you don’t take your money out of your savings account!

Reduced interest rates

Sometimes you’ll see reduced interest rates – like on our Clean Energy Home Loan if you purchase an energy efficient home.

But why do my interest rates change and how do you decide the interest rate?

Those are two great questions and there’s a lot of things that come into it.

One of them is the ‘cash rate’ that the RBA set. The RBA use the cash rate to influence what the 'market' (banks and other lenders) offers as an interest rate on home loans. You can read more about it here.

The other side of it is balancing our savers and our borrowers. As a customer owned bank, our depositors fund our loans so movements in rates paid by borrowers directly affect every person who saves with us.

Need a translation? We ‘use’ the money people have in their savings accounts to fund the people who want to borrow money to buy a home, start a business or get a credit card. So while a cut in rates may be what you want if you have a loan, that also cuts what savers earn. And likewise – as a saver you want a higher interest rate, but that needs to balance with not increasing repayments on home loans too much. It’s a tricky balance.

Got questions about how interest works? Hit us up on Instagram, Twitter or Facebook.

Disclaimer! The information provided is general information and is an opinion only. We cannot guarantee its accuracy. It is not advice. You should not rely on it to make decisions. If you need specific advice on your circumstances or finances you should speak to an expert. You might need legal or accounting or other specialist advice.  It depends on your personal circumstances. The information provided about Bank Australia is true and correct as at the date of publication.