Interest rates play a large role in our financial lives. They affect the true amount we owe on loans, credit card purchases and even what we earn in savings accounts. But knowing how rates work can be a bit confusing.
In its simplest form, interest is what lenders charge to borrow money and is often reflected as a percentage of the borrowed sum. When interest rates are high, it’s more expensive to borrow money and vice versa.
There are many different types of interest, depending on the type of loan or the way that it’s calculated. For example, mortgages, personal loans and credit cards all have different ways of calculating their interest. Those rates are determined by a number of factors, including the lender’s view of your ability to pay back what you borrow. Banks look at things like your FICO credit score and financial documents when determining your creditworthiness, among other things.
Another thing to consider is how frequently interest is compounded. This determines how quickly debt can grow over time. If you’re able to pay off your debt quickly, you can avoid paying a lot of interest.
Understanding interest rates can be a little tricky, but it’s important to know how they work. High rates mean you’ll pay more for loans, such as a car or a home, and lower ones mean that it’s less expensive to borrow. But even small differences in rates can have a big impact.