Interest rates are a key component of how you manage your finances. They determine the cost of borrowing and the return on your investments. Understanding how these dynamics affect you can help you make more informed financial decisions.
An interest rate is a percentage that is charged on a loan, deposit or savings account. It is based on three factors: the principal sum, compounding frequency and length of time.
For most people, interest is an unavoidable part of their lives – it’s what you pay when you borrow money, the way your bank account balance increases over time with compounding and the price you must pay for purchasing goods and services that come with a monthly or annual fee. It’s also the reason that a mortgage is more expensive than a car loan, even though the initial purchase amount is the same.
When interest rates rise, consumers and businesses tend to cut back on spending as prices increase for consumer staples and business investment stalls. However, higher rates typically benefit savers as the returns on savings accounts increase.
It’s important to distinguish between “interest rates” and other terms like APR (annual percentage rate). APR takes into account additional fees associated with a loan such as application, administration, or origination fees – which can make it harder to compare competing products.