Interest rates are a key component in many of the formal borrowing and lending transactions we experience. They are found in mortgage rates, the charge on our credit cards and student loans, growth of retirement funds, amortization of long-term assets and many other financial products and services.
In general, interest rates are determined in a free market where supply and demand meet. When there is high demand for money and credit, lenders will raise their rates to attract borrowers. When demand is low, they will lower rates to entice people to borrow.
There are some personal factors that can influence the rate you pay, notably your creditworthiness. Banks will look at your credit score, bank statements and other financial information before deciding what interest rate to offer you. Borrowers can also shop around and reveal their creditworthiness to different lenders to find the best rates.
The higher or lower your interest rate will impact your savings and investments. When interest rates rise, it typically makes debt more expensive and can crimp consumer spending. When rates fall, it can increase the income you earn on your savings and investments and may help bolster the value of real estate holdings.
When comparing savings and investment accounts, you should compare the effective annual interest rate rather than the nominal interest rate. The former takes into account inflation and bank fees while the latter doesn’t. In addition, you should also consider compounding periods (whether it is simple or compound) as this can significantly change the amount of interest you will pay.
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