Interest rates play a big role in the economy and in your personal financial life, from mortgages and auto loans to credit card debt and savings accounts. Whether you’re looking to save for the future or make smart investments, understanding how rates work can help you get the most out of your money.
Interest is a price charged for the use of assets such as cash or consumer goods and services. It compensates lenders for the risks and lost opportunities they incur by lending out their funds to borrowers, and it encourages prudent borrowing practices. When a loan is paid back, the borrower typically settles a total amount that includes both the principal and interest.
While the concept is simple enough, calculating interest can be complex. It depends on the type of debt, the currency involved, and the prevailing rate. Different types of debt are also subject to different rules and regulations. For example, a loan backed by collateral has less risk than a loan that doesn’t. A mortgage loan, for instance, is secured by the property a person or business owns.
As central banks modify interest rates, they influence the overall supply and demand for money within an economy. Lowering interest rates increases borrowing and spending to stimulate economic activity, while higher rates slow down borrowing and investment to control inflation and attain price stability and optimum employment. Aside from influencing borrowing costs and the economy, rates can also influence financial markets.
About the Author
