Interest rates play a major role in the economy and your personal finances. They determine how much it costs to borrow money and can dramatically impact the buying power of your savings or investments. Understanding how interest rates work can help you make more informed financial decisions.
In a nutshell, the interest rate is the amount that lenders charge to borrow money, or how much they earn on deposit accounts. It’s expressed as a percentage of the principal and is often noted on an annual basis. In general, a higher interest rate means it’s more expensive to borrow money; a lower interest rate means it’s cheaper to do so.
The interest rate on a loan or credit card account can vary based on several factors, including the type of debt and how it’s secured. For example, mortgage loans are typically secured by the property itself, which reduces a lender’s risk of not getting paid back. As such, these loans typically carry lower interest rates than personal or credit card debt.
Another factor is the overall state of the economy. For example, when unemployment is low and inflation is under control, it’s typically easier for borrowers to get approved for loans. This encourages spending and investment, which can spur economic growth. Conversely, when unemployment is high and inflation is rising, it’s more difficult to obtain a loan and savers can see their returns shrink.
For this reason, central banks frequently adjust interest rates to manage the economy. For example, when inflation is rising, they may raise rates to slow borrowing and investment; and when the economy is weak, they might lower rates to encourage lending and increase deposit yields.
About the Author
