Interest Rates

What Are Interest Rates?

An interest rate is the fee charged by a lender to a borrower, usually expressed as a percentage of the loan amount. For loans, the interest rate is typically stated on an annual basis as the annual percentage rate (APR). Alternatively, an interest rate can also be applied to savings accounts or certificates of deposit (CDs), where a financial institution pays a percentage of the deposited funds to the account holder. The interest earned on these deposit accounts is referred to as the annual percentage yield (APY).

Types of Interest Rates

Different types of interest rates include:

- Simple interest: This is computed solely based on the principal amount, without factoring in any accrued interest over time.

- Compound interest: Unlike simple interest, compound interest is calculated not only on the principal amount but also on the accumulated interest from previous periods. In essence, this means that interest is earned or paid on the interest itself.

Factors That Impact Interest Rates

Interest rates are influenced by various factors, such as:

- Central bank policies: Short-term interest rates are determined by central banks to manage the money supply and affect economic activity.

- Inflation: Higher inflation often results in higher interest rates to preserve the purchasing power of money.

- Credit risk: Lenders assess the risk associated with lending money, and borrowers with higher credit risk may face higher interest rates.

- Understanding interest rates is crucial for making informed financial decisions. Whether you're borrowing money, saving for the future, or investing, the impact of interest rates on your financial well-being is significant. It's important to monitor these rates to make wise financial decisions.