What Is Interest? Definition & How It's Calculated

Key takeaways:

Interest is the money you’re charged to access funds or credit, like a personal loan or credit card, respectively.
Interest rates may be simple or compound. Compound interest is more common—and typically more costly—than simple interest.
Factors like the Federal Reserve’s rates, your credit history, and the length and amount of your loan can impact your interest rate.

Whether you’re new to credit or an experienced borrower, you’ve likely heard the term “interest” floating around. Interest is a key feature of most kinds of credit, and it can have a significant impact on how much your loan will cost.

With that in mind, it pays to understand what interest is and how it works. In this guide, we’ll take a closer look at interest as it applies to borrowing. We’ll also discuss the most common types of interest, along with the factors creditors consider when setting your rate.

What is interest?

Interest is the amount of money you’re charged in exchange for access to credit. Interest is typically expressed as a percentage of the amount you borrow, known as the interest rate.

And the annual percentage rate (APR) is the total amount you’ll pay each year in interest and fees.

You can owe or earn interest, depending on whether you borrow or loan money. If you take out a loan, you’ll likely have to pay interest to your loan provider. But if you put money in a savings account, your bank may pay you interest in exchange for using your money.

How does interest work?

Interest is typically added on top of your debt principal, or your original loan amount. It applies to virtually every form of debt, including personal loans, mortgages, auto loans, credit cards, and more.

Interest charges usually mean you’ll end up paying your lender more than you originally borrowed. For example, consider the following loan breakdown.

Say you take out a $5,000 personal loan with a 10% interest rate, a 5-year term, and a base monthly payment of $83. When you add interest, your payment increases to $106 per month. By the time you reach your payoff date, you’ll pay about $1,300 in interest—bringing your total cost to $6,300.

Loan principal:	$5,000
Interest rate:	10%
Term:	5 years (60 months)
Base monthly payment:	$83
Principal + interest payment:	$106
Total interest	$1,374
Total cost of loan	$6,374

Pro tip: Higher interest rates often lead to more expensive debt, while lower interest rates make the cost of borrowing more affordable. It’s important to consider the rate of a loan or credit card before taking on more debt. You can also use a loan calculator to get an estimate of how much you’ll spend over the life of the loan.

Types of interest

Creditors may apply two main kinds of interest to debt: simple interest and compound interest. Let’s take a closer look at each.

What is simple interest?

Simple interest is based on the principal amount of your loan. You can calculate simple interest by multiplying the loan principal, interest rate, and loan term. If you take out a $10,000 loan with a simple interest rate of 5% and a 5-year term, your interest payments would total $2,500 over the life of your loan.

What is compound interest?

Compound interest is based on both the loan balance and its accrued interest. You can think of compound interest as “interest on interest.”

Compound interest can be calculated daily, weekly, monthly, or continually. Therefore, it often leads to higher costs for borrowers. For instance, consider the loan described above. If you exchange the simple rate for a compounding interest rate, you would owe about $2,800 in interest.

What is accrued interest?

Accrued interest is the amount of interest you’ve collected since your last payment. Most loan providers charge interest daily. Rather than forcing you to make daily payments, these charges are tracked and added to your monthly installments.

Part of your monthly payments go toward your accrued interest. The rest goes to your principal balance.

How interest is determined

Financial institutions calculate interest based on several factors, including:

Expected Federal Reserve interest rate hikes
Estimated inflation rates
The amount of money borrowed
The term of the loan
The opportunity cost of loaning you money (aka, the lender’s inability to use the money for other things)

Lenders also consider the borrower’s level of risk when determining interest rates. Your risk level is based on details like your repayment history, credit score, and borrowing habits.

If you have a history of solid financial habits and a good credit score, you’re more likely to get approved for a loan with a lower interest rate. If your credit could use some work, you may only qualify for a loan or credit card with a higher interest rate.

Lending marketplace like Upstart, look beyond your credit score and use your work experience and education¹ to help you find a personal loan.

Who pays interest on a loan?

The borrower is responsible for paying interest on debt, whether it’s a personal loan or a revolving credit card balance. Some credit card or loan companies offer a 0% introductory interest period, which may allow you to save money on interest. However, you’ll have to pay interest as soon as the introductory period closes.

Feeling empowered to make the most of your credit?

Interest is one of the most important factors to consider when taking out a loan. But it can be confusing, especially if you’re not sure how it works.

After reading this guide, you can feel more confident in your ability to identify interest rates, get a rough estimate of your total costs, and understand if you’re paying simple or compound interest.

If you’re still not sure what kind of interest rate you might face on a loan, reach out to your creditor for more information. That way, you can make an informed decision and get one step closer to a solid financial future.

¹Neither Upstart nor its bank partners have a minimum educational attainment requirement in order to be eligible for a loan.

Upstart Network, Inc. (NMLS #936133) is not a lender. All loans on its marketplace are made by regulated financial institutions.

All mortgage lending is conducted by Upstart Mortgage, LLC dba Upstart Home Lending. (NMLS #2443873). Equal Housing Opportunity.

Checking your rate won’t affect your credit score: When you check your rate, we check your credit report. This initial (soft) inquiry will not affect your credit score. If you accept your rate and proceed with your application, we do another (hard) credit inquiry that will impact your credit score. If you take out a loan, repayment information may be reported to the credit bureaus.
Upstart’s model considers education: Neither Upstart nor its lending partners have a minimum educational attainment requirement in order to be eligible for a loan.
41% more approvals and 33% lower rates than a traditional model: As of publication in April 2026, and based on a comparison between the Upstart model and a hypothetical traditional model using Upstart data from Jan – Dec 2025. For more information on the methodology behind this study, please see Upstart’s Annual Access to Credit results here.
Unsecured Loans: While most loans through Upstart are unsecured, certain lenders may place a lien on other accounts you hold with the same institution. There may be an option to secure your personal loan through Upstart with your vehicle, which will require a lien to be placed on the vehicle. It is important to review your promissory note for these details before accepting your loan.
Loan amounts from $1,000 -$75,000: Your loan amount will be determined based on your credit, income, and certain other information provided in your loan application. Not all applicants will qualify for the full amount. Minimum loan amounts vary by state: GA ($3,100), HI ($1,500), MA ($7,000). Maximum loan amounts may vary by state.
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APRs from 6.2% – 35.99%, with 3 or 5 year terms: The full range of available rates varies by state. The lowest rates are only available to the most qualified applicants. A representative example of payment terms for an unsecured Personal Loan is as follows: a borrower receives a loan of $10,000 for a term of 60 months, with an interest rate of 17.50% and a 7.25% origination fee of $725, for an APR of 21.23%. In this example, the borrower will receive $9275 and will make 60 monthly payments of $252. APR is calculated based on 5-year rates offered in March 2026. There is no downpayment and no prepayment penalty. Your APR will be determined based on your credit, income, and certain other information provided in your loan application. Not all applicants will be approved.
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HELOC APRs as low as 6.52%: Terms shown here are subject to change without notice. APRs for initial advances range from 6.52% to 18.00% based on rates offered as of April 2026. The lowest rate is only available to consumers willing to become a member of a credit union and to those who meet a minimum FICO score of 780, CLTV under 70%, and DTI under 45%. Your actual rate will depend on many factors such as your credit history, combined loan-to-value ratio (CLTV), line amount, loan term, lien position, and property state. Origination fee to open an account is between 0% and 4.99% of the approved credit limit. The Annual Percentage Rate (“APR”) is variable and based on the Prime Rate as published in the Wall Street Journal “Money Rates” table plus or minus a margin. Your APR will never be less than 3.99% or greater than 18.00%. Property insurance is required.
No annual fee, prepayment penalty, or fees to redraw: Terms shown here are subject to change without notice. Origination fee to open an account is between 0% and 4.99% of the approved credit limit. The Annual Percentage Rate (“APR”) is variable and based on the Prime Rate as published in the Wall Street Journal “Money Rates” table plus or minus a margin. Your APR will never be less than 3.99% or greater than 18.00%. Property insurance is required.
2,500+ Variables:As of 3/31/2026. “Variables,” often also referred to as “features,” refers to raw variables and combined variables considered in our AI models. A “raw” variable is a non-combined, conceptually distinct unit of data, such as “applicant-reported savings.” A “combined” variable is data that has been transformed, combined, or otherwise engineered from a raw variable or set of raw variables, such as “applicant-reported savings” divided by “loan amount.
Fully automated loans: In Q2 2026. Percentage of Loans Fully Automated, which is defined as the total number of loans in a given period originated end-to-end (from initial rate request to final funding for personal loans and small dollar loans, and from initial rate request to signing of the loan agreement for auto loans) with no human involvement required by the Company divided by the Transaction Volume, Number of Loans in the same period.

What Is Interest and How Does It Work?