Interest rates shape the total cost of debt and the growth potential of savings. Whether you’re making decisions on mortgages, credit cards or deposit accounts, understanding how interest works can help you save money and make smarter choices about how to spend and save your money.
Interest is a percentage that is charged on top of the amount borrowed. It is a reflection of the cost of lending money and represents the value of time (see other Ag Decision Maker Files on this topic).
The amount of interest charged will depend on the type of debt, its duration, and whether it is secured by assets. For example, mortgage loans are typically backed by real estate, which reduces the risk of not being repaid. Therefore, they may come with lower interest rates than personal loans or credit card debt that are not backed by assets.
Other factors that influence the amount of interest charged include the actual or expected inflation rate and the financial risk premium. The former refers to the amount of money that lenders want in exchange for lending out their funds to offset the loss of purchasing power due to inflation. The latter refers to the amount of money that the lender needs to compensate for the risk of not being repaid. If the lender expects a high level of non-repayment, they will likely charge a higher interest rate to cover this risk.
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