Interest rates are a vital aspect of most formal lending and borrowing transactions. They determine how much it costs to borrow money, the growth of savings accounts, investments and more. Understanding how and why they work is crucial to personal finances.
Interest is calculated as a percentage of the principal amount borrowed or lent and expressed over a specified period, typically a year, but sometimes in a less common way like daily, monthly or even weekly. The calculation of interest depends on many variables including the compounding frequency, duration and length of the loan or deposit, and the type of debt or investment (see below for a more detailed explanation).
Rising interest rates can have a number of impacts. For example, higher interest rates make it more expensive to buy a car or home with a mortgage and can lead to higher monthly payments. But it also means that the savings and earnings from interest-bearing accounts can grow faster, which is good for people who are saving for a down payment or other financial goals.
And when it comes to investments, a rise in interest rates can mean that returns on bonds will be higher (although this may not be the case for all investors). In general, it’s a boon for savings, which tend to invest heavily in government bonds and other safe investments that don’t require a lot of risk. It can also benefit pension funds and retirement accounts that rely on bond-based income to pay retirees their benefits.
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