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Whether you’re borrowing money from a lender or depositing money in a savings account, interest rates will play into your financial picture. Understanding exactly how they work is crucial to making the best possible decisions for your money and hitting your financial goals.

This guide provides the information you need to understand interest rates and how they work.

Interest Rate Definition

Interest rate is the cost of borrowing or the payoff of saving. Specifically, it refers to the percentage of interest a lender charges for a loan as well as the percentage of interest earned on an interest-bearing account or security.

Interest rates change frequently, but the average personal loan interest rate is dependent on several factors, including the amount borrowed, credit history, and income, among others. A borrower with an excellent credit score and a dependable income, for instance, will likely be considered low risk and may be offered a lower interest rate. On the flip side, some vehicles like payday loans are considered riskier for lenders and tend to have higher interest rates.

Recommended: What Is a No-Interest Loan? A Personal Loan Guide

How Interest Rates Work

Whether you’re borrowing or saving money, the interest rate is applied to the balance during set periods of time called compounding periods.

For borrowers, this extra charge can add to outstanding debt. For savers, savings interest can be one way to earn money without much effort.

Here, some specific examples.

You might take out a personal loan with an APR of 6.99%. That means you’ll pay an additional 6.99% of the loan balance each year in addition to the principal payments, which is paid to the lender for servicing the loan.

Or, if you hold a high-yield savings account that offers a 4.00% APY return, you can expect that account to grow by 4.00% of its balance each year. How often the interest is compounded will also impact the growth you enjoy.

Of course, the interest you might earn in a savings account is usually substantially lower than what you might earn on higher-risk investments.

And when it comes to any of the multiple uses of a personal loan, paying interest means you’re paying substantially more than you would if you were able to cover the expense out of pocket. However, you may be paying considerably less than if you were to use credit cards for a purchase.

Fixed vs Variable Interest Rates

Lenders charge fixed or variable interest rates.

As the name suggests, fixed interest rates remain the same throughout a set period of time or the entire term of the loan. Fixed rates can be higher than variable rates. Borrowers who prefer more predictable payments — or are borrowing when interest rates are low — may decide to go with a fixed-rate loan.

Variable interest rates change periodically, depending on changes in the market. This means the amount of your payments will vary. Generally speaking, variable-rate loans can be riskier for consumers, so they tend to have lower initial rates than fixed-rate loans. However, it’s important to note that when interest rates rise, so can the cost of borrowing. When borrowers decide to renegotiate from a variable-rate to a fixed-rate loan, they may face additional fees and a new loan length.

A variable-rate loan may be a good move for borrowers who plan to pay off the loan quickly or can take on the risk.

Types of Interest

While all interest does one of two things — accrue as a result of saving money or in payment to the bank for a loan — it can be calculated and assessed in different ways. Here are a few common types of interest rates explained.

Simple Interest

Simple interest is interest that is calculated, simply, based on the balance of your account or loan. This is unlike compound interest, which is based on the principal balance (the original money you borrowed) as well as interest accrued over time.

Most mortgages and auto loans are calculated using simple interest. That means you won’t pay additional interest on any interest charged on the loan.

For example, say a driver takes out a simple interest loan to pay for a new car. The loan amount is $31,500, and the annual interest rate on the loan is 4%. The term of the loan is five years. The driver will pay $580.12 per month. After five years, when the loan is satisfied, they will have paid a total of $34,807.23.

Compound Interest

Compound interest, on the other hand, means that interest is charged on not only the principal but also whatever interest accrues over the lifetime of that loan.

Say you take out an unsecured personal loan in the amount of $20,000 to pay for home remodeling. The loan is offered to you at an interest rate of 6.99% compounded monthly, and you must also pay an upfront fee of $500 for the loan. You’ll pay it back over the course of five years.

Over the course of those 60 payments, you’ll pay $3,755.78 in interest, not including the $500 extra you paid in fees. Each month, you’ll pay back some of the principal as well as the interest charged to you.

By the time you’re done with your home remodel, you’ll have paid $24,255.78 altogether, and that’s on a personal loan with a fairly low rate. In other words, you’ll have paid 20% more for the project than you would have if you’d funded it out of pocket.

Recommended: Simple Interest vs. Compound Interest

Amortized Interest

Amortizing loans are common in personal finance. If you have a home loan, auto loan, personal loan, or student loan, you likely have an amortizing loan.

Amortization is when a borrower makes monthly (usually equal) payments toward the loan principal and interest. Early payments largely go toward the calculated interest, while payments closer to the end of the loan term go more toward the principal.

The interest on an amortized loan is calculated based on the balance of the loan every time a payment is made. As you make more payments, the amount of interest you owe will decrease.

To see how payments are spread out over the life of the loan, borrowers can consult an amortization schedule. A mortgage calculator also shows amortization over time for a loan.

But here’s a look at a sample calculation:

Let’s say you take out a $200,000 mortgage over 10 years at a 5% fixed interest rate. Your monthly payments will be $2,121.31. Next, divide the interest rate by 12 equal monthly payments. That equals 0.4166% of interest per month. This means that in the first month of your loan, you’ll pay $833.33 toward interest and the remaining $1,287.98 toward your principal.

Now, how about the second month? To calculate what you’ll owe, deduct your monthly payment from the starting balance. (This will give you the “balance after payment” for the chart.) Be sure to add to the chart the $833.33 you paid in interest and the $1,287.98 you paid toward the principal. Repeat the calculation of monthly interest and principal breakdown for the rest of the chart, which includes 12 months of payments.

Precomputed Interest

Loans that calculate interest on a precomputed basis are less common than loans with either simple or compound interest. They’re also controversial and have been banned in some states. Precomputed interest has been banned nationally since 1992 for loans with terms longer than 61 months.

This method of computing interest is also known as the Rule of 78 and was originally based on a 12-month loan. The name is taken from adding up the numbers of the months in a year (or a 12-month loan), the sum of which is 78.

Interest is calculated ahead — precomputed — for each month and added to each month’s payment, giving more weight to interest in the beginning of the loan and tapering off until the end of the loan term. In the case of a 12-month loan, the first month’s interest would be 12/78 of the total interest, the second month’s interest would be 11/78 of the total interest, and so on.

Here’s an example: Say a borrower takes out a personal loan with a 12-month term that will accrue $5,000 in interest charges. According to the Rule of 78, here’s what the borrower would pay in interest each month:

A loan with precomputed interest has a greater effect on someone who plans to pay off their loan early than one who plans to make regular payments over the entire life of the loan.

APR vs APY

Whether compound or simple, interest rates are generally expressed as APR (annual percentage rate) or APY (annual percentage yield). These figures make it easier for borrowers to see what they can expect to pay or earn in interest over the course of an entire year of the loan or interest-bearing account’s lifetime.

However, APY takes compound interest into account, whereas usually APR does not — but on the other hand, APR takes into account various loan fees and other costs, which APY might skip.

Recommended: APY vs. Interest Rate: What’s the Difference?

How Are Interest Rates Determined?

Lenders use several factors to determine the interest rate on a personal loan, including details about your financial background and about the loan itself.

When lenders talk about a borrower’s creditworthiness, they’re usually referring to elements of your financial background. This may include:

•   Your credit history

•   Your income and employment

•   How much debt you already have

•   Whether you have a cosigner

The loan terms can also affect the rate. For example, personal loan rates can be affected by:

•   The size of the loan

•   The duration of the loan

Loan term is something borrowers should be thinking about as well. A longer loan term might sound appealing because it makes each monthly payment lower. But it’s important to understand that a longer-term loan may cost you significantly more over time due to interest charges accumulating.


💡 Quick Tip: In a climate where interest rates are rising, you’re likely better off with a fixed interest rate than a variable rate, even though the variable rate is initially lower. On the flip side, if rates are falling, you may be better off with a variable interest rate.

Interest Rates and Discrimination

Generally speaking, the higher your credit score and income level, the easier it is to qualify for loans with better terms and lower interest rates — which, of course, can make it more difficult for people in lower socioeconomic positions to climb their way out.

Discriminatory lending has had a long history in the U.S. Before federal laws protecting against discrimination in lending practice, lenders would regularly base credit decisions on factors such as applicant’s race, color, religion, sex, and other group identifiers rather than their creditworthiness.

The practice of “redlining” was begun in the 1930s as a way to restrict federal funding for neighborhoods deemed risky by federal mortgage lenders. It persisted for decades, and the detrimental effects can still be felt today by residents of minority neighborhoods.

Since residents of redlined neighborhoods were excluded from approval for regular mortgage loans, they were forced to look for other financing options, which were often exploitive. If they could not find any lender willing to loan to them, they continued renting, unable to gain equity in homeownership.

The Takeaway

The interest rate is the cost of borrowing money — it’s a percentage of the total amount of the loan. It can also refer to the rate at which interest is earned on money in a savings account, certificate of deposit, or certain investments. The amount of interest you’ll pay is usually expressed using percentages, which will be listed as either APR (annual percentage rate) or APY (annual percentage yield), depending on which kind of financial product you’re talking about. When borrowing, it can be wise to access the lowest rates possible to minimize the interest you pay.

Think twice before turning to high-interest credit cards. Consider a SoFi personal loan instead. SoFi offers competitive fixed rates and same-day funding. See your rate in minutes.

FAQ

What is the definition of interest rate?

An interest rate is expressed as a percentage and is used to calculate how much interest you would pay on a loan in one year (APR), or how much you would earn on an interest-bearing account in one year (APY).

What is an example of an interest rate?

Simple, compound, or precomputed interest rates are types of interest rates commonly used.

What is the difference between interest and interest rate?

Interest is the money you’re charged when you take out a loan — or earn for leaving your money in a deposit account to grow. Interest rate is the percentage you’re being charged or are earning.

What happens when interest rates are high?

Interest rate increases tend to lead to higher interest rates on personal loans, mortgages, and credit cards. It can also mean costlier financing for borrowers.

Can you adjust the interest rate on a personal loan?

Possibly. One way to lower the interest rate on a personal loan is to refinance it with another lender.

Photo credit: iStock/Remitski

SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.

SOPL-Q325-040

After a years-long payment pause because of the pandemic, federal student loan payments resumed on October 1, 2023 (and interest accrual resumed a month earlier). The result is that millions of federal student loan borrowers are making payments again.

However, some borrowers may opt to make more than the student loan minimum payment so that they can expedite the repayment process on their loan. Here’s what borrowers need to know about paying more than the minimum on student loans.

What Is the Minimum Payment on Student Loans?

The minimum payment on student loans is the lowest amount of money a borrower can pay each month. The actual student loan minimum payment amount owed each month might be determined by factors including the loan type, interest rate, and the student loan repayment plan. Generally, the minimum monthly payment includes the principal (the original amount borrowed), interest, and fees.

For federal student loans, the minimum monthly payment depends on the repayment plan a borrower is on. However, the U.S. domestic policy bill that was passed in July 2025 eliminates a number of federal repayment plans. For borrowers taking out their first loans on or after July 1, 2026, there will be only two repayment options. But because current borrowers may remain in the plans, they are included here.

Standard Repayment Plan: This plan will continue to be available in a modified form moving forward. Most borrowers were eligible for the original plan, which had a 10-year repayment period. For loans taken out on or after July 1, 2026, the repayment term will range from 10 to 25 years based on the loan amount.

Pay As You Earn (PAYE) Plan: This plan will be closed to new loans made on or after July 1, 2026. Under PAYE, borrowers’ payments were 10% of their discretionary income and were also based on their family size. With PAYE, their payment could be as low as $0 per month, and they wouldn’t owe more monthly than they would have on the Standard Repayment Plan.

Income-Based Repayment Plan: IBR is available to any borrower currently in an income-driven plan that is scheduled to close. Borrowers on this plan generally have federal student loan debt that’s higher than — or comprises a substantial portion of — their annual discretionary income. On IBR, their monthly payments are 10% to 15% of their discretionary income, and could be as low as $0. Borrowers won’t owe more monthly than they would have paid on the Standard Plan.

Income-Contingent Repayment Plan: This plan will be closed to new loans made on or after July 1, 2026. Borrowers with Direct loans who were eligible for this plan had monthly payments that were the lesser of 20% of their discretionary income or the amount they would have paid on a fixed repayment plan over 12 years, adjusted for their income. Their payments may have been as low as $0 a month.

Saving on a Valuable Education (SAVE) Plan: The SAVE plan is scheduled to be eliminated by June 30, 2028. Those who are already on the plan had their loans in interest-free forbearance since summer 2024. However, interest began to accrue on these loans again on August 1, 2025. Payments remain paused, but borrowers can move to another plan; those who don’t change to another plan on their own will likely be moved to the IBR plan.

Graduated Repayment Plan: This plan will be closed to new loans made on or after July 1, 2026. With this plan, a borrower’s monthly payments were lower at first and then increased, usually every two years. The monthly amounts they paid were enough to repay their loans within 10 years.

Extended Repayment Plan: This plan will be closed to new loans made on or after July 1, 2026. For those on the Extended plan, their payments may have been fixed or graduated, and the amount they paid each month was enough to ensure their loans would be paid off in 25 years.

As noted above, for borrowers taking out their first loans on or after July 1, 2026, there will be only two repayment options:

•  Standard Plan: This refashioned plan will have fixed payments with a term based on the loan amount and ranging from 10 to 25 years. Generally, the more you owe, the longer you will have to repay it.

•  Repayment Assistance Program (RAP): This new program is similar to previous income-driven plans that tied payments to income level and family size. On RAP, payments range from 1% to 10% of adjusted gross income for up to 30 years. At that point, any remaining debt will be forgiven. If your monthly payment doesn’t cover the interest owed, the interest will be cancelled.

You can learn more about the federal repayment plans here.

Can I Pay More Than The Minimum on Student Loans?

It’s possible to make more than the minimum payment on student loans without being charged for any prepayment penalty fees. Both federal student loans and private student loans are required to allow borrowers to make extra payments and pay off their loan early without charging any additional fees.

Making extra payments can help decrease the interest paid and help reduce the overall cost of the loan. Typically, you can contact your lender to specify that the extra payment be applied to your highest interest loan and be applied to the principal value of the loan.

Making payments directly to the principal value of the loan can help speed up repayment. And, because most student loan interest is charged per day, making additional payments on the principal value of the loan can help reduce the amount you pay in interest over the life of the loan.


💡 Quick Tip: Often, the main goal of refinancing is to lower the interest rate on your student loans — federal and/or private — by taking out one loan with a new rate to replace your existing loans. Refinancing can make sense if you qualify for a lower rate and you don’t plan to use federal repayment programs or protections, since refinancing federal loans makes them ineligible for federal benefits.

Why Would You Pay off Your Student Debt Sooner?

As with any debt, a primary motive for paying off student debt early is to more quickly eliminate debt that’s racking up interest. Prioritizing debt repayment could help lower your debt to income ratio and could help you reduce the amount of money you owe in interest over the life of the loan. Here are a few reasons you may want to pay off your student loans sooner rather than later.

Interest. Interest. Interest.

Interest continues to accrue for the life of most student loans. (Note: The timetable of when interest starts to accrue on your student loans depends on the type of student loans you’ve been awarded. Contact your lender for all the details.) The sooner you pay off your loans, the sooner you stop interest from accruing.

Student loan interest does qualify for a tax deduction. But only $2,500 of the interest can be deducted each year — less if your modified adjusted gross income in 2025 is greater than $85,000 annually for those who are single and more than $170,000 for those who are married and filing jointly.

Your Debt-to-Income Ratio May Be Lowered

When borrowing a mortgage or a car loan, the lender will usually consider the applicant’s debt-to-income ratio. And the lower it is, the better it looks from a financial perspective. Do you need a new car? Want to buy a house? Start a family? The sooner you get your student loan debt paid off, the more money you will likely have to put toward those dreams being realized.

Your Credit Score Could Strengthen

Your FICO® credit score is a powerful component of your total financial picture. There’s something to be said for the fact that if you’re managing an open debt responsibly by making on-time payments, that may have a positive impact on your credit score. And a higher FICO® score can generally help an individual get a better interest rate on a loan they might need for a home or car.

It’s Easier to Save Money When You’re Not Paying Down Debt

The conventional wisdom is the less debt you have, the more money you likely have to save. Think of successfully managing and paying off debt as a necessary exercise routine, like working your core. As your financial “core” gets stronger, you’re likely to become better able to balance your finances and save more money.

When you’ve repaid your student loans, the money you were spending each month on loan payments can instead be used to help you reach financial goals like starting an emergency fund, saving for a down payment on a house, or more.

How to Accelerate Your Student Loan Payments

You may be able to pay off your student loan debt more quickly by setting reasonable goals, including payments larger than the student loan repayment minimum required. As mentioned, both federal and private student loans generally allow for penalty-free prepayment but be sure to contact your loan provider before doing so to ensure your prepayments are being applied in the way that you want them to be.

Here is a checklist that may help you eliminate your student loan debt sooner.

Calculating Your Costs

Make a list or spreadsheet of all your student loans. You can use a student loan calculator to help determine how much you ultimately owe (including interest) and when, ideally, you’d like to complete your student loan payments.

Making a Budget

Track your spending and make a realistic budget of your monthly and annual expenses. And leave some wiggle room for unexpected expenditures. Be honest with yourself. If you feel you’re spending too much on unnecessary expenses, maybe it’s time to skip your next urge to splurge.

Setting Manageable Goals

Now that you know how much money you have coming in and where it’s going, it might be time to make some uncomfortable, but fair, spending decisions with the intention of eliminating your student loans by your goal date. That means you may want to sacrifice some unnecessary expenses. Cutting back on non-necessities isn’t fun, but it may make it easier for you to save.

Paying Beyond the Minimum Required

As we mentioned, you can accelerate your loan payoff by paying more than the minimum student loan payment required by your loan provider. It’s okay to start small — even an extra $25 a month can start to add up. Paying more each month can also save you money on interest. You can ask your loan provider to put that extra cash toward the principal.

Avoiding Late Fees

An easy way to help ensure you pay at the same time every month is to set up an auto-draft from your checking or savings account. Some lenders may even offer a rate discount to student loan borrowers who enroll in automatic payments.

Maximizing “Surprise” Money

Are you doing so well at work that you got a raise or bonus? Rather than splurging on something new, lighten the burden of your current reality by putting that money toward your student loan debt.

Finding Extra Work

Every little bit of extra income can help. A part-time job could get you closer to your goal more quickly. If fitting in an extra 15 or 20 scheduled hours a week isn’t feasible, try finding a side hustle where you can make your own hours. You can work as a dog walker, become a rideshare driver, or even recharge electric scooters.

Recommended: What is the Average Student Loan Debt After College?

Refinancing Your Student Loans

Refinancing your student loans might offer yet another step closer to your goal. Student loan refinancing is when you borrow a new loan (which is used to pay off your original loans) at a new interest rate and/or a new loan term.

One potential benefit of refinancing is the possibility of securing a lower interest rate. You could also potentially shorten your loan repayment term. But opting to shorten your loan term generally means paying more each month.

If you have a combination of private and federal loans, it’s possible to roll them into a single refinanced loan, which means having one monthly payment instead of multiple payments to multiple lenders.

However, it’s very important to understand that by refinancing your federal loans, you lose federal student loan protections such as deferment and forbearance, and access to income-driven repayment programs. Take this into very careful consideration before moving forward with student loan refinancing with a private lender.

The Takeaway

Making more than the minimum student loan payments each month can help borrowers speed up their loan repayment and spend less in interest over the life of their loan. Lenders generally do not charge any fees for prepayment. To make the most of your extra payments, contact your lender to be sure they are being made to the principal value of the loan.

Refinancing could be another option for some borrowers to consider if they are interested in securing a lower interest rate on their loan — and provided that they don’t need access to federal programs or protections.

Looking to lower your monthly student loan payment? Refinancing may be one way to do it — by extending your loan term, getting a lower interest rate than what you currently have, or both. (Please note that refinancing federal loans makes them ineligible for federal forgiveness and protections. Also, lengthening your loan term may mean paying more in interest over the life of the loan.) SoFi student loan refinancing offers flexible terms that fit your budget.

FAQ

What happens if I only pay the minimum on my student loans?

Making the minimum monthly payments on your student loan will generally result in your loan being paid off according to the original terms of the loan.

Is it worth paying off student loans early?

Paying off student loans ahead of schedule can make borrowing less expensive, because the borrower will likely spend less in interest over the life of the loan. Repaying student loans early could also have benefits like improving an individual’s debt-to-income ratio. Without the burden of student loans, borrowers might also be able to focus on other financial goals.

What is the average minimum student loan payment?

A borrower’s average monthly minimum federal student loan payment depends on factors including the total amount they owe, their interest rate, and the type of payment plan they’re enrolled in. For instance, for those currently on the Standard Repayment Plan, your payments are a fixed minimum amount of at least $50 a month.

SoFi Student Loan Refinance
Terms and conditions apply. SoFi Refinance Student Loans are private loans. When you refinance federal loans with a SoFi loan, YOU FORFEIT YOUR ELIGIBILITY FOR ALL FEDERAL LOAN BENEFITS, including all flexible federal repayment and forgiveness options that are or may become available to federal student loan borrowers including, but not limited to: Public Service Loan Forgiveness (PSLF), Income-Based Repayment, Income-Contingent Repayment, extended repayment plans, PAYE or SAVE. Lowest rates reserved for the most creditworthy borrowers. Learn more at SoFi.com/eligibility. SoFi Refinance Student Loans are originated by SoFi Bank, N.A. Member FDIC. NMLS #696891 (www.nmlsconsumeraccess.org).

SoFi Private Student Loans
Please borrow responsibly. SoFi Private Student loans are not a substitute for federal loans, grants, and work-study programs. We encourage you to evaluate all your federal student aid options before you consider any private loans, including ours. Read our FAQs.

Terms and conditions apply. SOFI RESERVES THE RIGHT TO MODIFY OR DISCONTINUE PRODUCTS AND BENEFITS AT ANY TIME WITHOUT NOTICE. SoFi Private Student loans are subject to program terms and restrictions, such as completion of a loan application and self-certification form, verification of application information, the student's at least half-time enrollment in a degree program at a SoFi-participating school, and, if applicable, a co-signer. In addition, borrowers must be U.S. citizens or other eligible status, be residing in the U.S., Puerto Rico, U.S. Virgin Islands, or American Samoa, and must meet SoFi’s underwriting requirements, including verification of sufficient income to support your ability to repay. Minimum loan amount is $1,000. See SoFi.com/eligibility for more information. Lowest rates reserved for the most creditworthy borrowers. SoFi reserves the right to modify eligibility criteria at any time. This information is subject to change. This information is current as of 4/22/2025 and is subject to change. SoFi Private Student loans are originated by SoFi Bank, N.A. Member FDIC. NMLS #696891 (www.nmlsconsumeraccess.org).

SoFi Loan Products
SoFi loans are originated by SoFi Bank, N.A., NMLS #696891 (Member FDIC). For additional product-specific legal and licensing information, see SoFi.com/legal. Equal Housing Lender.