Interest is the cost of borrowing money — or the reward for lending it. It's one of the most fundamental concepts in personal finance, and understanding it will change how you think about credit cards, loans, mortgages, and savings accounts.
When you borrow money, you pay back the original amount (called the principal) plus an extra fee for the privilege of using someone else's money. That extra fee is interest.
When you save money in a bank account or invest, the bank or investment pays you for letting them use your money. That payment is also interest.
In both cases, interest is expressed as a percentage of the amount borrowed or saved, usually over a year. This is called the interest rate.
You borrow $1,000 from a bank at 10% annual interest. After one year, you owe $1,000 (the principal) plus $100 (10% of $1,000) in interest — a total of $1,100.
Flip it around: you deposit $1,000 in a savings account earning 4% annual interest. After one year, you have $1,000 plus $40 in interest — a total of $1,040.
There are two main types of interest: simple and compound. The difference matters a lot over time.
Simple interest is calculated only on the original principal. If you borrow $1,000 at 10% simple interest for 3 years, you pay $100 in interest each year — a total of $300 in interest over 3 years, for a total repayment of $1,300.
Simple interest is rare for most consumer products in Canada. Car loans sometimes use a version of it, but most financial products use compound interest.
Compound interest is calculated on the principal plus any interest already accumulated. Your interest earns interest. This has a huge effect over time — for better or worse depending on whether you're saving or borrowing.
Example: You borrow $1,000 at 10% interest, compounded annually, for 3 years:
With simple interest, you'd owe $1,300 after 3 years. With compound interest, you owe $1,331. The gap seems small over 3 years, but over 20–30 years, it becomes enormous.
Interest rates vary widely depending on what you're borrowing for and your credit profile:
The higher the rate, the more expensive borrowing becomes. A credit card at 19.99% on a $3,000 balance you only make minimum payments on can cost you thousands in interest before the debt is cleared.
The Bank of Canada sets the policy interest rate (also called the overnight rate or key rate). This is the rate at which major banks lend to each other overnight. It's the most powerful lever the Bank of Canada has to control inflation and the broader economy.
When the Bank of Canada raises its rate, borrowing becomes more expensive for everyone: banks raise mortgage rates, line of credit rates, and credit card rates. When the Bank lowers its rate, borrowing gets cheaper. In 2022–2023, the Bank raised rates aggressively to fight inflation, pushing the policy rate from 0.25% to 5%. By 2025, it had been cut back down to around 2.75%–3% as inflation eased.
This matters to you because your variable-rate mortgage, home equity line of credit (HELOC), or variable-rate student loan moves up and down with the Bank of Canada's rate.
In Canada, lenders are required to disclose the Annual Percentage Rate (APR) — which includes not just the interest rate but also any fees. This gives you a more complete picture of the true cost of borrowing.
For example, a personal loan might advertise a 12% interest rate, but after including origination fees, the APR might be 15%. When comparing loan offers, always compare APRs, not just the stated interest rate.
Most Canadian credit cards charge interest at 19.99% per year. But they don't charge it annually — they charge it monthly or even daily. Here's how it works:
The grace period matters: if you pay your full statement balance by the due date, you pay zero interest — even though you used the card. Interest only kicks in when you carry a balance from one statement to the next.
Canadian mortgages compound semi-annually (twice a year) by law, not monthly as in the US. The stated rate and the effective annual rate are slightly different because of this. In practice, the difference is small, but it's why your lender shows you both the nominal rate and the effective annual rate.
On a $400,000 mortgage at 5% over 25 years with monthly payments of roughly $2,326, you'll pay about $297,900 in total interest over the life of the mortgage — nearly as much as you borrowed. Making even small extra payments significantly reduces this.
Interest income is fully taxable in Canada. If your savings account earns $400 in interest, you add that $400 to your income and pay tax on it at your marginal rate. This is one reason TFSAs are valuable — interest earned inside a TFSA is completely tax-free.
Interest paid on money borrowed for investment purposes (like to buy stocks or rental property) is generally tax-deductible. Interest on personal debt (credit cards, car loans, personal mortgages on your primary home) is not.
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