Interest rates impact everything from borrowing to saving to investing, and understanding them can be critical to managing your finances. Whether you’re shopping for loans like a mortgage or car loan, looking into savings account rates, certificates of deposit (CDs) or money market accounts (MMAs), or planning to buy bonds, interest rates shape the total cost of debt and the growth potential of deposits.
An important factor in determining loan rates, especially those of credit card loans and other uncollateralized debt, is the lender’s perception of risk. If a borrower may be less likely to repay the borrowed funds, the lender is more likely to charge higher interest rates than those charged on secured debt such as a mortgage or auto loan. Additionally, a large down payment can reduce a lender’s overall risk and lower loan rates.
In addition to the cost of debt, interest rates also reflect the value of time. Over the life of a loan, money that’s borrowed will typically become worth more than the original principal because it’s lost to inflation and opportunity costs (the amount of money the lender could have invested during the loan term). Lenders compensate for this by charging interest on the principal amount.
In savings accounts and CDs, interest rates are often compounded daily or monthly, and the resulting amount owed or earned is known as accrued interest. This type of calculation is used to ensure that savers are being paid a fair rate for the use of their money.
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