Interest rates are a major part of everyone’s life. You pay them when you take out a loan, especially on credit cards and mortgages, but they also influence how much your investments make and the buying power of savings accounts. Understanding how interest works can help you take control of your finances and avoid paying more than you should, or losing out on investment income that you could have earned.
When Rates Are High
The amount you owe on debt and the returns on investments are influenced by interest rates, which are set by a country’s central bank (e.g., the Federal Reserve in the U.S.). When the cost of borrowing is high, it discourages people and businesses from spending and slows consumer demand. This is the goal of most central banks when they raise interest rates.
When the cost of borrowing is low, people and businesses spend more freely and demand for goods and services rises. This is usually a good thing for the economy, but it can lead to overheating and inflation that requires a central bank to raise interest rates in order to cool things down.
Individual lenders, credit unions and banks have their own criteria for setting interest rates based on a variety of factors including the state of the economy, the availability of capital and the amount of risk associated with lending. These factors can be uncontrollable, but individuals can still use the rate fluctuations to their advantage. For example, a rise in interest rates typically brings higher yields on savings account products and Certificates of Deposit (CDs), which can help individuals achieve better paydays from their savings vehicles.