Interest rates play a big role in our lives. Consumers think about them when considering a loan or credit card; market watchers follow them for what they say about business conditions and corporate prospects; the Federal Reserve adjusts them to keep the economy running smoothly.
An interest rate is the amount charged by lenders to borrowers for the use of their money, expressed as a percentage of the principal or original sum borrowed. It is typically based on the number of periods in a year, although it can be expressed monthly, daily, or any other period. Interest is calculated using either simple or compounding methods. Simple interest is a straightforward calculation that adds the interest to the principle; compounding adds the interest to the accumulated sum of principal and interest from previous periods.
The type of debt also affects the amount of interest paid. Mortgage loans, for example, typically have lower interest rates than personal loans or credit card debts that are not secured by a borrower’s home or other assets. Mortgages are also considered less risky because the bank can foreclose on the home if the borrower defaults.
Finally, the length of the loan or debt may influence the interest rate. Longer loans or debts tend to have higher interest rates than shorter ones, as there is more time for the borrower to default or miss payments. Borrowers and borrowers often find it helpful to shop around for the best available interest rates, taking into account factors such as their credit scores and history, as well as economic trends.