Interest Rates Guide

Our guide explains interest rates and how they affect borrowing, saving and investing.

Updated 27 August 2024

Interest rates indicate the price of borrowing money for a mortgage, personal loan, credit card and even student loans. Understanding how interest rates work, and how they are different, can be complicated.

In this guide we explain the basics of interest rates, covering:
1. The interest rate you pay to borrow money

Mortgage interest rates, including fixed and variable/floating rates
Credit card interest rates
Personal loan and general debt interest rates

2. The interest rate you receive when you save money or have money on deposit

Bank account interest rates
Term deposit interest rates

3. How tax affects interest rates
4. Compound interest explained

Know this first: If at any time you feel a bit overwhelmed, don't worry - interest rates can be complicated. Understanding the basics will help you with everyday transactions and this is the most important thing.

The Basics of Interest Rates

Explained: The interest rate you pay to borrow money

If you borrow money and the interest rate is 10% a year, it will cost you 10% of the amount borrowed to do so. You will repay the amount you borrow as well as pay the interest over a set period of time, i.e. five years. Interest rates, whether it's for a loan, credit card or mortgage, are always quoted annually.

A typical example:
Q: How much does it cost to borrow $10,000 at 10% then repay it six months later?
A: The answer is answered by a simple math formula. 10% of $10,000 is $1,000, and this is what you would pay if you borrowed the money for one year. In this case, it's a six month loan, so you would pay half of $1,000 - i.e. $500. It is as simple as this - you may see interest rates like 18.99% or 5.75% but the cost of borrowing is all calculated in the same way.

Borrowing interest rates are all around us
We've listed some examples below of interest rates you will see advertised in the newspaper, on TV, online or at the bank:

A bank's interest rate for a mortgage

A lender's interest rate for a personal loan

A credit card's interest rate

Explained: The interest rate you receive when you save money or have money on deposit

The interest rate you earn works exactly the same way as if you borrow. The reason is simple - if you loan money to a bank or keep it in your account, it will lend it out to other people and pay you interest for the privilege of doing so. The interest rate on savings and deposits is what the bank pays you.

A typical example:
Q: How much will you make by investing $1,000 at 3.50% for two years?
A: The answer is a simple maths formula. 3.5% of $1,000 is $35, and this is what you would receive each year if you invested the money. In this case, it's a two year investment, so you would receive two $35 payments, meaning you will make a total of $70. It is as simple as this - you may see interest rates like 1.99% or 4.50%, but the money you make from investing is all calculated the same way.

Investing interest rates are all around us
We've listed some examples below of interest rates you will see advertised in the newspaper, on TV, online or at the bank:

A bank's interest rate for a short-term deposit

A bank's interest rate promotion on deposits

A bank's interest rate for a short-term deposit

Explained: How tax affects interest rates

Borrowing money: If you borrow money, you won't pay any tax on the interest. You only pay back what you owe and the interest costs - there is no GST on interest etc.
Investing money: When you earn money from investing savings in term deposits, the interest you are paid counts as 'income', and you will pay tax on this income. The amount of tax you pay depends on how much you earn in total when you add up your employment and savings income.

Tax on tax interest income from term deposits and bank interest
The IRD has four resident withholding tax rates. You will need to insert your tax rate, which depends on how much you earn. The default tax rate is 17.50% if you don't select a tax rate. The table beloe outlines the RWT tax rates:

If your taxable income is:	Then for interest you receive, your RWT rate is:
Up to $14,000	10.5%
Over $14,000 and up to $48,000	17.5%
Over $48,000 and up to $70,000	30%
Remaining income over $70,000	33%

A typical example:
Q: How much tax will you make by investing $1,000 at 5% for one year?
A: The answer is it depends on how much you earn. We'll assume you earn below $48,000. In this case, 5% of $1,000 is $50, and this is what you would receive as a 'gross amount'. When you deduct tax, you get the 'net amount'. In this case, the 17.50% tax rate applied to $50 is $8.75. This means the amount you receive as income is $41.25 and $8.75 is paid to the IRD.

Explained: Compound interest

Compound interest is a concept at the heart of borrowing and saving, and for this reason alone, it is essential to understand what it is.

Firstly, 'simple interest' is based on the principal amount of a loan or deposit, while compound interest is based on the principal amount and the interest that accumulates on it in every period (interest on interest).

To explain further, compound interest is the 'addition of interest to the principal sum of a loan or deposit, or in other words, interest on interest'. Compound interest can be a saver's dream and a borrower's nightmare. We outline some examples below to best explain the concept.

Savings - Why Compound Interest is Fantastic:
A typical example::

Suppose you had $1,000 in a savings account which paid 10% annual interest after tax.
After year one you'd have $1,000 plus $100 interest (10% of $1,000), giving a total of $1,100.
After year two, you'd earn 10% on your new savings total, $1,100 (the $100 last year was added to your savings).
10% of $1,100 is $110 - so you return so far from the original $1,000 investment is $210 ($100 from the first year and $110 from the second)
At the end of year three, you will earn interest on the interest from year two, and, if this makes sense, interest on the interest on the interest from year one.
This example demonstrates how compound interest works.

What does this mean for my savings?

Your money grows much more quickly when it compounds because you earn interest on the interest, which makes your investment larger and larger as time goes on.
Generally, the longer you save for, the greater the effect of compound interest.

Another example:

If you invest the original $1,000 for 20 years at the same 10% interest rate (simple interest), you would have $3,000 in total (20 years of $100/year plus the original $1,000 investment).
But, if you compounded the interest, your total investment would be worth $6,727.50.
Our compound interest calculator has more information and simplifies doing your own calculations.

Borrowing - Why Compound Interest is a Nightmare:
Just as the benefit of compound interest for savers means big returns, the effect on borrowers can be problematic. In essence, compound interest leads to bigger debts if you take longer to repay what you owe.

Worst of all, compound interest has a more severe effect on debts than on savings because interest rates for borrowing are much higher. As an example, if you borrow $5,000 at 15% over 5 years without making any monthly repayments, you'd owe a massive $10,535 (without compound interest you would owe $8,750).

For mortgages, personal loans and credit cards, interest is typically compounded monthly. Cards like GEM Visa and the Q Card compound interest daily, which make the borrowing very expensive.

Remember: if you are unsure about anything, ask for the details to be explained

Interest rates can be confusing, and we suggest speaking to your lender if you are unsure about anything.
Fees can also be charged on top of interest rates, so you will need to have these explained to you.
It's your legal right to have interest rates explained so you fully understand the costs of borrowing.
Our top 10 mortgage rates guide has the latest deals from the banks and a helpful FAQ section which covers home loans.