Interest rates are the amount of money borrowers pay or earn on borrowed funds. They can affect everything from the cost of a car loan to the return on savings in a bank account. The interest rate can be either fixed or variable, and varies by the borrower’s creditworthiness. Usually, the lender takes your FICO credit score and other financial documents into consideration before deciding your interest rate.
Borrowers pay interest when they take out loans such as credit card debt, student and mortgage debt. Lenders also earn interest on deposits, such as the interest paid on a savings account or certificate of deposit (CD). The annual percentage yield (APY) is the rate that reflects compounding and is typically noted as a percentage of the principal, or total amount borrowed.
Generally, the strength of the economy drives interest rates up and down. When economic conditions are strong, businesses’ and individuals’ desires to spend more than they take in as revenues tend to drive interest rates up. In contrast, when economic conditions are weak, companies’ and individuals’ desire to save tends to drive interest rates down.
Central banks, such as the Federal Reserve, modify interest rates in order to accomplish several macroeconomic goals, such as price stability, full employment and sustainable economic growth. Understanding how interest charges work helps people and businesses make informed decisions about borrowing and investing. In addition, knowing how interest rates influence monetary policy can help people understand the role of government in the economy.
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