The Difference Between Fixed and Variable Interest Rates
Interest rates are a key part of how loans and investments work. Understanding the difference between fixed and variable rates can help you make savvy financial decisions that fit your lifestyle and goals.
In lending, an interest rate is a fee that lenders charge to borrowers for the use of assets (such as cash or consumer goods). Interest rates are also used to describe the annual percentage yield (APY) earned by savings accounts at banks and credit unions. Savings accounts and CDs earn compound interest.
The state of the economy influences interest rates. High interest rates tend to discourage borrowing and slow economic growth, while low rates encourage more borrowing and investment.
Different types of debt and savings instruments have varying interest rates. Credit cards, payday loans and home mortgages typically have higher interest rates than car loans or personal loans. Mortgages and personal loans are also usually secured by a property or other asset, which makes them less risky for lenders. This reduces the lender’s exposure and may allow them to offer lower interest rates.
There are also differences between simple and compound interest rates. Simple interest is calculated on the principal only, whereas compound interest is calculated on the principal plus accumulated interest from previous periods. Simple interest is generally more favorable when borrowing money, while compounding is more beneficial when investing money.
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