Interest rates are an important part of everyone’s financial life, whether they are borrowing money or saving it. They affect how much people pay for goods and services, what companies are able to invest in, and even their retirement plans. But they can be confusing, so let’s take a look at how they work.
An interest rate is the amount charged by a lender or financial institution for lending its funds to another party, or for putting its money in a savings account. It is often expressed as a percentage of the principal sum borrowed or deposited over a specific period, such as a year.
The interest rate paid by a borrower can vary depending on the type of debt being taken out, such as mortgage, car, or credit card debt. It may also be affected by the economy, as interest rates typically go up in a strong economic climate and down during a weak one.
Interest rates can be calculated using either simple or compound interest. Compound interest is more complex, and is the method used for most formal loan calculations. For more information and to do calculations with compound interest, please visit the Compound Interest Calculator.
Lastly, the actual rate of interest on loans or savings can be “fixed” or “floating.” Fixed interest rates are set when the loan is made and remain the same over the term of the loan. This provides a level of certainty for borrowers, as they know what their payments will be each month, and can help them plan better. Floating rates, however, are based on other reference rates, such as the Fed Funds Rate or the LIBOR (London Interbank Offered Rate).
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