Interest rates play a critical role in our personal and financial lives. They determine how much debt costs and how much we earn on our savings. But, there are a lot of factors that influence the magnitude of interest rates. So, it’s important to understand how they work.
Basically, the interest rate is the price that lenders charge for borrowing their money. It’s calculated as a percentage of the borrowed amount and is typically noted on an annual basis. The same principle applies to savings and investments accounts, where interest is paid as a percentage of the money that you deposit in a particular account. For example, a bank might pay you an interest rate of 10% on the balance in your savings account. This is also known as compounding.
In a broader sense, interest rates are vital to a healthy economy because they encourage individuals to spend and borrow money. Lower interest rates make it more affordable for people to get loans, while higher ones tend to discourage borrowing and cause people to save more money.
Of course, a single individual’s lending and saving habits won’t have as big of an impact on interest rates as the overall supply and demand for credit. But, that doesn’t mean that you should ignore how rising and falling interest rates affect your personal finances. For example, if the Fed raises rates, you might want to consider reworking your saving and spending priorities.
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