Interest rates play an important role in financial decision-making whether you’re comparing loans or saving for retirement. Understanding how they work may help you save money on debt and earn more on savings or investments.
Generally, an interest rate is the price you pay to use someone else’s money, or the reward you receive for letting them lend you funds. It’s a way for lenders to make money and it encourages borrowing and saving that fuels economic growth.
The factors that determine interest rates are complex. They include the size of the loan or deposit (larger loans typically have higher rates since they pose more risk to the lender over time) and the length of the term of the deposit or loan (shorter terms tend to have lower rates). Creditworthiness is another factor, with people who have better credit scores often qualifying for loans with a lower interest rate.
In addition to these influencing factors, the current state of the economy can have an impact on interest rates, either by increasing or decreasing them. High rates can make borrowing more expensive and slow economic activity, while low rates can stimulate borrowing and spending. Inflation is also a consideration when making interest calculations, as it changes the buying power of each dollar. The nominal interest rate — which is typically advertised for savings accounts and loans — ignores inflation, while the real rate takes into account the impact of inflation on the principal.
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