Interest rates shape the financial landscape in both ways: they dictate the cost of borrowing and influence the return on savings and investments. Understanding how they work is crucial for individuals managing their finances. From securing a loan or mortgage to growing savings in a bank account, credit card, certificate of deposit (CD) or investment account, there are many factors that determine the amount of interest paid or earned.
Several things can impact the interest rate you pay or earn, including the type of debt or savings instrument, its duration and whether it’s fixed or variable. For example, mortgage loans tend to have lower interest rates than personal and credit card debt because they’re secured by a home, reducing the lender’s risk. And deposits in bank accounts and CDs often come with varying rates depending on the institution’s size, its business model and competitive positioning.
Other factors include the lender’s level of risk and its need for income. For instance, larger loans pose more of a risk to lenders than smaller ones, and so they typically have higher interest rates. A longer repayment term can also result in higher interest rates because it may take the lender more time to receive full payment for its loan.
Other factors can include the prevailing inflation rate and the fees and expenses associated with the loan or savings instrument. For example, the nominal interest rate that’s advertised to savers and borrowers often ignores inflation, while real interest rates factor in the impact of inflation on the value of money and potential earnings lost from opportunity costs.
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