Interest rates are obviously important when it comes to economics and personal finance. It’s a term you hear all the time in several different capacities, but what does it really mean, and more importantly, what does it mean for you? Read on and you’ll see!

We’ll cover the definition of the term interest rates, both in its usage as a reference to collective rates and for an individual loan, plus what makes interest rates rise and fall.

Basic Definition of Interest Rate

Interest rate refers to the amount of a loan that is charged to the recipient for the privilege of borrowing money. It’s generally an annual percentage of the loaned amount that is still owed that's charged to the borrower to be remitted as a part of the regular payments. Most simply put, interest rates are the cost of borrowing money or other items.

The vast majority of loans will come with interest charges, whether it’s a $100 payday loan or a million-dollar mortgage.

Interest Rate as a Collective Term

You’ve probably heard interest rates referred to on an economic level rather than simply in regards to a single loan transaction.

Interest rates are set by the central banks in an economy. This doesn’t mean that the interest rate set by the central banks will be the interest rate on every single loan available, but instead acts as a guide to lenders of all kinds. Interest rates set by central banks are referred to as a ‘nominal interest rate’, while the interest rates actually charged by lenders for a specific product are referred to as ‘real interest rates’.

Lenders are behooved to stick closely to this rate suggested by the central bank to keep up with the competition. In the U.S., the guiding interest rate is set by the Federal Reserve.

What Makes Interest Rates Change?

There are several factors that affect interest rates, but one of the main factors has to do with current bond prices. When bond prices go up, interest rates go down. Conversely, when bond prices go down, interest rates go up.

The Federal Reserve adjusts interest rates to help balance the amount of money put out with the expected amount of money put out. They do this in an effort to keep the economy stable and, ideally, growing at a sustainable rate.

Another factor that affects interest rates is simple supply and demand. When more people need loans, loans get more expensive because people are more likely to pay the additional interest for them. When people don’t need loans, lenders must lower interest rates in an effort to draw in customers and convince them to purchase their loan products. The amount of money banks have to lend also affects interest rates based on supply and demand.

Current Interest Rates

Current interest rates are on the rise, which means that loans are likely to cost you a little more than they did. Interest rates may affect the economy as a whole, including housing prices. If you’re thinking of selling your home either conventionally or through Sell & Stay and are concerned about how rising interest rates may impact the housing market, contact us immediately to learn more and maybe get the ball rolling while rates are lower and housing values are higher!

Key Takeaways

Interest rates are an often unavoidable part of economics and personal finance so it's important to have a good understanding of what they are, how they're determined, and why they change. Speak with your financial advisor to learn what you should be paying in interest rates.