Interest rates play critical roles in how much it costs to borrow money and how much you can earn from investments. Understanding how they work can help you make better financial decisions and manage your money.
The interest rate is the amount you pay to the lender for the use of the borrowed funds. It is typically expressed as a percentage of the principal. The interest rate is what lenders require to compensate them for the loss of the ability to invest the funds during the loan period and also for the time value of the money invested by the borrower (which is equivalent to their opportunity cost).
When it comes to loans and credit, you can choose between a fixed or variable rate. Each type has its own set of pros and cons. Fixed rates are consistent over the life of your loan and provide stability, making budgeting easier. However, they can be a bit more expensive at the outset as they tend to start higher than variable rates.
The amount of interest you pay depends on several factors including the type of debt you take out, your creditworthiness, and economic trends. The interest rates on mortgages, for instance, are usually lower than those on personal loans and credit cards because they are often secured by the borrower’s home or other assets. In addition, the federal government often uses the power of eminent domain to help protect mortgage borrowers against foreclosure.