Interest rates play a critical role in our financial lives, influencing everything from how much we pay for mortgages and cars to how much we earn on our savings. Yet, they can be complicated to understand. This article will help you learn how they work and how different factors impact them.
The rate at which you pay or earn is determined by the amount of money you have borrowed or invested, and the length of time over which the loan or investment is applied. This is a function of the risk involved and the opportunity cost of the borrowed or invested money (the lost potential use for it).
Different types of loans and debts also have different interest rates. These reflect the relative risk involved for the lender, as well as the borrower’s creditworthiness and ability to pay back the principal amount plus interest over the term of the loan or investment. Some lenders may have a fixed interest rate and others, such as credit cards and personal loans, have variable rates.
A fixed interest rate means that the rate you pay stays the same for the entire life of the loan, regardless of market trends or economic conditions. This can make it easier to budget and can provide a sense of stability. On the other hand, if you’re comfortable taking some risk and have an eye on market trends, a variable rate could save you money in the long run.