Interest rates play a big role in your financial life. They determine how much it costs to borrow money, how fast your savings or investments grow and how quickly you pay off debt.
An interest rate is the amount charged, expressed as a percentage of principal (the total amount borrowed or invested) over a period of time, usually a year, though it can be calculated on a different basis. It is the primary method by which lenders earn income for the money they lend or invest, and it is the main reason that credit card debt can add up so quickly, or why it’s so difficult to save enough for a comfortable retirement.
Many things affect the size and structure of interest rates, from lender policies to Federal Reserve policy to the overall strength or weakness of the economy. The most important factor, however, is supply and demand. If there is high demand for loans and deposits, then interest rates will rise, to attract more borrowers. Conversely, when there is low demand for loans and deposits, interest rates will fall to attract more borrowers.
There are also several other factors that influence the nature of an interest rate, including the length of a loan or deposit term and how frequently interest is compounded. In general, higher rates are applied to longer-term loans and deposits, and more frequent compounding results in greater interest payments. The broader economy also impacts interest rates, as low or rising inflation can have an effect on the relative value of dollars.
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