Interest rates influence everything from how much debt costs to the growth potential of savings accounts. And whether you’re a borrower, saver or both, understanding how they work can help you make better financial decisions.
A person or business lends money to another person or business for a fee, called interest. This fee covers the cost of lending the money and compensates the lender for losing the use of their funds during the loan period. The amount of the borrowed funds that are repaid is known as the principal.
When a bank or other entity offers you a personal loan, they take many factors into account before deciding what rate to charge you, including your creditworthiness, which is based on your FICO score and other financial information. The type of debt you have also influences the rate you pay, with mortgage loans typically attracting lower interest than credit card and other non-mortgage debts that aren’t secured by collateral.
In addition to these personal and structural variables, the current state of the economy influences the level of prevailing interest rates. For example, when the economy is strong, the demand for borrowing tends to be high and so do the rates charged. When the economy is weak or slowing, however, people are less willing to borrow and so interest rates are generally low.
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