What is Interest Rate?

An interest rate is the cost of borrowing money or the return for saving it, expressed as an annual percentage of the principal amount.

The interest rate determines how much extra you pay on a loan or earn on a deposit. Central banks set a benchmark rate (SNB policy rate, ECB deposit rate) that influences all other rates in the economy. Mortgages, car loans and savings accounts move with it.

Nominal rate is the headline number on the contract. Real rate subtracts inflation — a 4% savings account during 5% inflation is actually losing 1% of purchasing power per year. Effective annual rate (EAR) accounts for compounding frequency and is the fairer comparison.

Fixed rates lock you in for a period and protect against rises but offer no benefit if rates fall. Variable rates float with the reference index — cheaper on average but riskier in tightening cycles.

Formula

Real rate ≈ Nominal rate − Inflation rate

Example

A 2.5% mortgage with 3% inflation has a real cost of just −0.5%: inflation is effectively repaying part of the debt for you.

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Related terms

APR

APR (Annual Percentage Rate) is the total yearly cost of a loan expressed as a percentage, including the nominal interest rate plus mandatory fees, allowing fair comparison between offers.

Mortgage

A mortgage is a long-term loan secured by real estate, used to finance the purchase of a home or commercial property, repaid in monthly instalments over 10 to 30 years.

Amortization

Amortization is the gradual repayment of a loan's principal through scheduled instalments, where each payment covers both interest and a shrinking share of the original balance.

Compound Interest

Compound interest is interest earned on both the original principal and on the interest that has previously been added to the account, producing exponential growth over time.

Frequently asked questions

Why do central banks change interest rates?+

To control inflation. Raising rates cools demand and slows price rises; lowering rates stimulates borrowing and spending.

What's the difference between nominal and effective rate?+

Nominal is the stated annual rate. Effective accounts for compounding frequency and is always equal to or higher than nominal.

Why are mortgage rates higher than savings rates?+

Banks profit on the spread — they pay savers less than they charge borrowers, covering operating costs, default risk and capital requirements.