Whether you’re buying a home, managing your credit or building savings in your bank account, interest rates shape the financial landscape and should always be a part of your decision-making process. Understanding the dynamics of interest rates can help you secure a better deal on your next loan, manage your debt more effectively and make smarter investments.
What is interest rate?
Interest is a fee, expressed as a percentage, that a lender charges to borrow money. It’s also the return a lender receives for investing funds over a specified period of time. In loans, interest is added to the principal sum, so that the total amount repaid is greater than the original borrowed sum. It’s common for lenders to report the cost of borrowing using an annual percentage rate, or APR, which includes both the interest charged and any fees associated with a loan.
Personal factors, like your creditworthiness, play a big role in determining the interest rate you’re offered. Banks use information from your FICO credit score and other sources to assess your risk profile and determine if you’re eligible for certain loans. The type of loan and its purpose impact the amount you’ll pay, with secured loans like mortgages typically offering lower rates than unsecured loans such as credit cards.
The strength of the economy and the willingness of individuals, businesses and governments to save can also affect interest rates. When economies are strong, people tend to spend more and invest in projects and buildings, which drives up interest rates, while weaker economic conditions lead to less spending and investment, resulting in lower interest rates.