Interest rates are a key component of the financial system and your personal finances. They determine how much your debt costs and how much you earn from investments. Understanding how they work and why they rise and fall can help you make wiser decisions about spending, saving and investing.
An interest rate is the price an entity pays or receives for lending money, expressed as a percentage of what is borrowed. It can apply to loans, savings accounts or other deposit products such as certificates of deposit (CDs). Interest is the primary method by which lenders earn income from their funds. When you take out a loan or buy a car, you are typically charged interest on top of the principal amount you borrow. Similarly, when you invest in securities such as stocks and bonds, you earn interest on the original investment plus any additional amounts earned over time.
There are many factors that influence interest rates, including the supply and demand for credit or money. When there is more demand, interest rates will be higher. When there is less demand, interest rates will be lower. Individuals can also impact their interest rates, primarily by maintaining a healthy credit score and being mindful of how they use their credit cards and other debt.
You may choose to have a fixed or variable interest rate on a loan. There are advantages and disadvantages to both options, so it is important to understand them in order to make the right decision for you.