Interest rates are a crucial aspect of borrowing and saving. Understanding how they work is essential for anyone managing their finances, whether it be securing a mortgage, buying a car or building savings in a bank account. But the exact definition of interest rate can get confusing.
In essence, an interest rate is a charge to the borrower for the use of assets, such as cash or consumer goods. The amount of money owed is added to the principal, and is then repaid either in one lump sum at a predetermined date or in periodic installments. There are many factors that influence interest rates, including risk-based pricing (where lenders assess a person’s creditworthiness or ability to repay debt), loan repayment periods, collateral and down payments, the type of asset borrowed and the purpose of the loan.
Ultimately, the state of the economy influences interest rates. When interest rates are low, people have more access to capital funding through debt, stimulating consumption and fueling growth. However, low interest rates can also lead to market disequilibrium in which demand exceeds supply, driving inflation.
In addition to being a major component of lending, an interest rate is also the rate of return on investments such as stocks or certificates of deposit. These rates are influenced by the state of the economy, but also by individual investor preferences and market conditions. To better understand how interest rates impact investment decisions, explore our in-depth article on understanding interest rates.
