Interest rates affect the daily lives of everyone who deals with money. However, it is safe to assume that most people did not grow up thinking about interest rates or even studying the concept at school. After all, the subject of interest rates may seem like a lofty topic primarily relevant for bankers or economics professionals. However, interest rates can determine our satisfaction in anything from buying an automobile to signing up for a credit card to saving up for a dream vacation. A look at how interest rates influence the way we borrow and save money can help you make informed financial decisions.
What Is an Interest Rate?
Interest rates refer to the cost of borrowing money or the reward for lending or saving it. Economists describe interest rates using percentages. For example, interest rates let borrowers know how much they need to pay over time in exchange for the privilege of using the money right away. Interest rates can affect all types of borrowers whether they are taking out a loan, credit card, or mortgage. On the other side of the coin, interest rates also inform savers or lenders how much money they can earn. For example, individuals who save money in a high-yield savings account or certificate of deposit (CO) can use interest rates to see how much they will make for letting the bank use their money for a period of time.
As an example, suppose a person decides to purchase a used vehicle with a loan of $8,000. The $8,000 is also known as the principal amount the individual wants to borrow. If the annual interest rate is 5.0%, this means that the person needs to pay 5.0% of $8,000 each year for the privilege of borrowing the money. This translates into $400 per year in addition to paying back the principal of the loan. The longer it takes the person to pay back the long, the more they may end up paying in interest.
Why Are Interest Rates Important?
Interest rates can have a major impact on your expenses or earnings. If you are borrowing money, a lower interest rate can help you spend less money overall. But if you are saving money, high interest rates may help you earn more each year. For example, automobile loans with high interest rates affect the price of your monthly payment over a set period. This means if you need to pay back your loan within 10 years, the lender may charge higher installments so that you can pay back the principal and interest in time.
Likewise, credit cards with high interest rates can mean that you end up paying back hundreds more than the price of your original purchase. For this reason, borrowers should also remain mindful if their cards have variable interest rates since this means the lender can adjust monthly payment amounts depending on the state of the market. Finally, even small changes in interest rates can affect expenses or earnings if the principal is large enough. For instance, even a 2.0% change in mortgage interest rates can translate into thousands more paid over the lifetime of the loan. Likewise, even a slight boost in interest rate on a large savings account can increase your net earnings for the year.
Who Determines Interest Rates?
Monetary interest rates fall under the discretion of the Federal Reserve. Also abbreviated as “The Fed,” this agency comprises the central banking system of the United States. It also sets monetary policy by establishing the federal funds rate. Any changes to this rate directly influence market interest rates and helps determine how cheap or expensive it is to borrow across the whole consumer economy. When the Fed raises the federal funds rate, borrowing can become more expensive. This may have the side effect of slowing down spending, but it can also result in greater returns for savings accounts.
When the Fed lowers the funds rate, it becomes cheaper for consumers to borrow. This can mean that more people end up taking out loans or spending on everything from assets to retail. At the same time, a lower rate can mean that savings accounts see lowered returns. Regulators for the Federal Reserve tend to adjust rates to achieve monetary goals like lowering inflation or stimulating economic growth. They have also been known to change rates following research or changes in the accepted consensus on modern economic theory.
How Can You Get the Best Interest Rate?
Once you learn that it is important to check interest rate, there are ways to explore how to get the best deal when you decide to borrow or save money. The first step is to check your credit score. Many lenders use this score to determine whether it is risky to lend money to you. In other words, they use the score as a metric to decide how likely you are to pay the loan back on time without defaulting or bailing. If you have a stronger credit score, you typically qualify for the best interest rates when borrowing money. If you want to improve your credit score, take a few months to pay your bills on time and reduce your debt-to-come ratio. You can also speak to a professional about strategies like consolidating debt into a single monthly payment, refinancing loans you already have, or obtaining a secured credit card to show you can make payments on time.
In addition to looking at your credit score, it is also important to compare offers from different lenders. Just as it feels natural to compare prices before booking an airline ticket, it should feel second nature to compare interest rates prior to picking a loan. Conventional banks, credit units, and online lenders or fintech companies can all have wildly varying interest rates. Do your research to get the best deal. Another idea is to consider a co-signer with great credit who is willing to help. A co-signer with a great credit history can help you qualify for better rates.
The Bottom Line
Learning about interest rates is more than abstract math. By understanding this percentage, you can feel more secure about borrowing or saving for your budgetary needs.
Interest rates affect the daily lives of everyone who deals with money. However, it is safe to assume that most people did not grow up thinking about interest rates or even studying the concept at school. After all, the subject of interest rates may seem like a lofty topic primarily relevant for bankers or economics professionals. However, interest rates can determine our satisfaction in anything from buying an automobile to signing up for a credit card to saving up for a dream vacation. A look at how interest rates influence the way we borrow and save money can help you make informed financial decisions.
What Is an Interest Rate?
Interest rates refer to the cost of borrowing money or the reward for lending or saving it. Economists describe interest rates using percentages. For example, interest rates let borrowers know how much they need to pay over time in exchange for the privilege of using the money right away. Interest rates can affect all types of borrowers whether they are taking out a loan, credit card, or mortgage. On the other side of the coin, interest rates also inform savers or lenders how much money they can earn. For example, individuals who save money in a high-yield savings account or certificate of deposit (CO) can use interest rates to see how much they will make for letting the bank use their money for a period of time.
As an example, suppose a person decides to purchase a used vehicle with a loan of $8,000. The $8,000 is also known as the principal amount the individual wants to borrow. If the annual interest rate is 5.0%, this means that the person needs to pay 5.0% of $8,000 each year for the privilege of borrowing the money. This translates into $400 per year in addition to paying back the principal of the loan. The longer it takes the person to pay back the long, the more they may end up paying in interest.
Why Are Interest Rates Important?
Interest rates can have a major impact on your expenses or earnings. If you are borrowing money, a lower interest rate can help you spend less money overall. But if you are saving money, high interest rates may help you earn more each year. For example, automobile loans with high interest rates affect the price of your monthly payment over a set period. This means if you need to pay back your loan within 10 years, the lender may charge higher installments so that you can pay back the principal and interest in time.
Likewise, credit cards with high interest rates can mean that you end up paying back hundreds more than the price of your original purchase. For this reason, borrowers should also remain mindful if their cards have variable interest rates since this means the lender can adjust monthly payment amounts depending on the state of the market. Finally, even small changes in interest rates can affect expenses or earnings if the principal is large enough. For instance, even a 2.0% change in mortgage interest rates can translate into thousands more paid over the lifetime of the loan. Likewise, even a slight boost in interest rate on a large savings account can increase your net earnings for the year.
Who Determines Interest Rates?
Monetary interest rates fall under the discretion of the Federal Reserve. Also abbreviated as “The Fed,” this agency comprises the central banking system of the United States. It also sets monetary policy by establishing the federal funds rate. Any changes to this rate directly influence market interest rates and helps determine how cheap or expensive it is to borrow across the whole consumer economy. When the Fed raises the federal funds rate, borrowing can become more expensive. This may have the side effect of slowing down spending, but it can also result in greater returns for savings accounts.
When the Fed lowers the funds rate, it becomes cheaper for consumers to borrow. This can mean that more people end up taking out loans or spending on everything from assets to retail. At the same time, a lower rate can mean that savings accounts see lowered returns. Regulators for the Federal Reserve tend to adjust rates to achieve monetary goals like lowering inflation or stimulating economic growth. They have also been known to change rates following research or changes in the accepted consensus on modern economic theory.
How Can You Get the Best Interest Rate?
Once you learn that it is important to check interest rate, there are ways to explore how to get the best deal when you decide to borrow or save money. The first step is to check your credit score. Many lenders use this score to determine whether it is risky to lend money to you. In other words, they use the score as a metric to decide how likely you are to pay the loan back on time without defaulting or bailing. If you have a stronger credit score, you typically qualify for the best interest rates when borrowing money. If you want to improve your credit score, take a few months to pay your bills on time and reduce your debt-to-come ratio. You can also speak to a professional about strategies like consolidating debt into a single monthly payment, refinancing loans you already have, or obtaining a secured credit card to show you can make payments on time.
In addition to looking at your credit score, it is also important to compare offers from different lenders. Just as it feels natural to compare prices before booking an airline ticket, it should feel second nature to compare interest rates prior to picking a loan. Conventional banks, credit units, and online lenders or fintech companies can all have wildly varying interest rates. Do your research to get the best deal. Another idea is to consider a co-signer with great credit who is willing to help. A co-signer with a great credit history can help you qualify for better rates.
The Bottom Line
Learning about interest rates is more than abstract math. By understanding this percentage, you can feel more secure about borrowing or saving for your budgetary needs.
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