Interest plays a critical role in every aspect of your financial life. It’s involved in nearly all formal lending or borrowing transactions, from the charges on a credit card to the repayment of mortgage loans, car loans and other consumer debt to business loan amortization, retirement savings growth, and even the purchase of long-term assets like property.
Understanding how interest works is an essential part of managing your personal finances and making smart choices about spending, saving and investing. Whether you’re planning for your retirement, buying a new home or a car, or saving for college tuition, understanding how interest rates work can help you make better financial decisions.
There are many different types of interest rates, depending on the type of investment or savings product you choose. The term of the loan, savings or investment product also influences the rate. For example, fixed rates are set as a percentage for the lifetime of the investment or loan, while variable rates fluctuate over time based on changes to another interest rate, inflation or a market index.
In general, the higher the interest rate, the more expensive it is to borrow money. This is because the lender must make a profit on the loan in order to cover their cost of capital and to recoup their initial investment. High interest rates can impact the broader economy by slowing down consumer spending and business investments, or stimulating economic activity through lower borrowing costs.