Interest rates tell you how expensive it is to borrow money, or what the return on savings is. So what are interest rates and why are they important. Let’s find out by reading the article below.
What are interest rates?
The interest rate is the amount charged by the lender to the borrower as a percentage of the principal (loan amount). The interest rate on the loan is usually calculated on an annual basis, known as the Annual Percentage Rate (APR).
Interest rates also apply to amounts earned from savings accounts or certificates of deposit (CDs) at banks or credit unions. Annual Yield (APY) refers to the interest earned on these deposit accounts.
Why are they important?
One way interest rates matter is that they affect the cost of borrowing and the spending decisions of households and businesses.
For example, lower interest rates encourage more people to take out mortgages to buy a new home or to borrow money to buy a car or renovate their home. Lower interest rates also encourage businesses to borrow money to invest in expansion, such as buying new equipment, updating factories or hiring more workers. Higher interest rates would limit such borrowing by consumers and businesses.
Why is the interest rate on a 30-year loan higher than the interest rate on a 15-year loan?
Interest rates are a function of default risk and opportunity cost. Longer-term loans and debts are inherently riskier because borrowers have more time to default. At the same time, the longer the time period, the greater the opportunity cost, during which the principal is tied up and cannot be used for any other purpose.
I hope this article will help you to learn what are interest rates and why are they important. Interest rates are affected by the borrower's credit score, income ratio, market factors, inflation, and more.
