Interest rates are a key part of our financial lives and determine how much debt costs and how much we earn on savings. They also have implications for the economy and investment portfolios. But understanding them can be complicated. So we’ve distilled the basics into this article to help you understand how they work.
Essentially, interest is the fee charged by lenders for the use of their money. It is typically calculated as a percentage of the amount borrowed. It is used to compensate lenders for the opportunity cost of not investing their funds during the loan period. The amount of interest paid can differ based on the type of loan, whether it’s mortgage loans, credit card debt or other forms of personal borrowing. A key factor in determining the level of interest paid is the lender’s view of the borrower’s risk, such as a person’s creditworthiness or business’s ability to repay the loan.
When interest rates rise, it makes it more expensive to borrow and discourages consumers from spending, companies from investing and the overall economy from growing. However, it can take time for these effects to play out. In the meantime, stocks can be volatile as investors seek shelter from rising rates. Bonds, on the other hand, often benefit from higher rates as they provide a steady income stream for investors without taking additional default risk.