From mortgage loans to savings accounts, interest rates impact the cost of borrowing and the return on investment for saving. Understanding how they work can help you make informed financial decisions that affect your everyday budget.
In general, interest rates are charged on borrowed money to compensate lenders for the time they have invested in lending their funds. Interest charges are calculated as a percentage of the principal amount that is loaned out. Borrowed money can be repaid in a lump sum or in periodic installments. For example, a payday loan with repayment due in two weeks will have a interest charge of $15 per $100 borrowed, or around 400% APR.
Credit cards and other debts that are not secured by collateral typically have higher interest rates than a mortgage or bank certificate of deposit (CD). Additionally, the compounding frequency of an account – whether it is calculated annually, monthly, daily or another interval – can also have an impact on the amount of interest accumulated.
Low interest rates make it easier to borrow and invest in riskier assets, which can stimulate economic activity. High interest rates, however, can make it more expensive to borrow money and may discourage people from spending, thus slowing economic growth.
Individuals can monitor their interest rates by checking the terms and conditions of their credit card or bank account online, as well as keeping an eye on the Federal Reserve’s monetary policy announcements. While there are many factors that influence interest rates, the overall goal of the Fed is to keep inflation in check.
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