Interest rates are a vital part of your financial life, shaping the total cost of debt and growth potential for savings and investments. Understanding the basics of what interest is and how it works may help you save on loans and maximize returns on savings. A variety of factors can affect interest rates, including compounding frequency, loan terms and whether a rate is fixed or variable.
The most common type of interest is simple interest, expressed as a percentage of the principal over a period of time, such as a year. More complicated is compound interest, which takes the principal and calculates an additional amount each month based on the previous amount and current amount.
A variable interest rate means the lender adjusts the rate to reflect market conditions. A fixed interest rate, on the other hand, remains unchanged for the entire term of the loan. This consistency can be helpful for borrowers as it allows them to know how much they will pay or earn each month and make budgeting easier.
When interest rates are high, borrowing becomes more expensive, potentially slowing economic activity. Conversely, when interest rates are low, it can be more advantageous for borrowers to take on debt and for savers to invest in assets. The factors that influence interest rates are complex, but a key factor is the monetary policy of a country’s central bank. Other key influences include inflation and global investment flows.