Interest rates play important roles in our daily lives, from determining how much a loan or credit card costs to impacting the returns on certain investments. Understanding how they work and what influences them can help you make better financial decisions.
Interest is a fee that lenders charge borrowers to cover the cost of borrowing money or property. It is usually calculated as a percentage of the amount borrowed or the original principal.
How and why interest is calculated differs depending on the type of debt or investment involved. For example, mortgage loans typically have lower interest rates than personal loans or credit cards because they are secured by real estate or other assets that the lender can repossess to reduce potential losses if a borrower defaults.
Other factors influence interest rates, including supply and demand, prevailing market rates, and the availability of credit. When there is high demand for loans and credit, lenders may raise rates to attract borrowers; when demand decreases, they will lower rates to encourage borrowing and spending.
The rate of interest paid or earned also depends on the length of the loan or investment term. For example, if you borrow $100 for six months at an interest rate of 3% per year, the amount you owe at the end of the six-month period will be equal to or greater than the original principal because the interest is compounding. You can calculate simple interest as well, which is less complicated because it does not take into account any interest earned or paid in previous periods.