Interest rates are a key part of your finances, whether you’re borrowing money to pay for a home or investing in savings accounts. The amount of interest you pay or earn depends on a variety of factors, and understanding how these work can help you make smarter choices when managing your money.
A borrower’s interest rate is the amount they are charged for the use of a lender’s money, usually expressed as a percentage of the principal, or original amount borrowed. For example, if you borrow $100,000 at an interest rate of 8%, at year-end you’ll be obligated to pay back $108. Borrowers typically seek the lowest possible interest rates, while lenders, or investors, prefer high ones for larger profits.
The exact calculation of interest varies, but most loans and credit cards are quoted with an annual percentage rate (APR) that reflects the yearly cost of debt. The APR is more comprehensive than just the interest rate, however; it includes any fees and charges tacked onto the total amount owed, including taxes and other add-ons.
Personal characteristics also play a role in the interest rate a person or business pays, with higher incomes often translating to lower interest rates. Other important factors include the economy, as low rates encourage spending and investment, while high rates can slow economic growth and job markets. In addition, the type of debt a person or business takes on can influence their interest rate. Mortgages, for instance, tend to carry lower interest rates than credit card or personal loans that aren’t secured by property or other assets.