Interest rates are a key component of borrowing, spending and saving. They impact the broader economy by encouraging or discouraging consumer spending and business investment, as well as influencing foreign exchange rates and the profitability of savings vehicles like bank accounts and retirement funds.
The term “interest rate” refers to the percentage charged or earned on borrowed money, and it’s typically applied over a specified period, known as the loan or savings term. A higher interest rate means it will cost more to borrow, while a lower one makes it less expensive to do so.
An interest rate is calculated based on many factors, including the borrower’s creditworthiness and the overall economic climate. For example, a lender may examine a borrower’s FICO credit score and other financial documents to determine their “creditworthiness,” or the likelihood of them paying off their debt.
In addition, borrowers can find information about their specific interest rates by checking the fine print of their loan or savings agreement. Often, they are listed as APR (Annual Percentage Rate), or APY (Annual Percentage Yield) to help them compare loans and savings options. APR includes fees and charges for the loan, while APY also takes compounding into account.
In general, it’s important for individuals to understand how interest rates work, so they can make more informed financial decisions. In fact, a better understanding of interest rates can save or lose thousands — or even tens of thousands — over the lifetime of a large loan such as a mortgage.