Interest rates shape the financial landscape and should play an important role in your decision-making, whether it’s for borrowing or saving. Understanding how they work can help you avoid overpaying for credit and make smarter savings decisions.
Interest is a payment made for the use of an asset, such as cash or property. When an interest rate is higher, it makes it more expensive to borrow money or invest in savings vehicles, such as a certificate of deposit (CD). In addition, interest rates influence the buying power of each dollar in your bank account and the amount of time it takes to save for specific goals.
There are many factors that affect interest rates, including the type of debt and the risk level associated with it. For example, mortgage loans are often backed by real estate and have lower interest rates than personal or credit card debts that are not secured. Similarly, the amount of equity in a business — or the amount of capital invested in it by shareholders — influences the interest rate because it limits how much losses can be incurred before the debt-to-asset ratio is impacted.
Another factor that influences interest rates is whether it’s fixed or variable. With a fixed interest rate, your payments will remain the same over the course of the loan term and can make budgeting easier. However, if market interest rates drop during your loan’s term, you won’t benefit from the lower rates and may end up paying more in the long run.
About the Author
