Interest rates are a fundamental concept that influence both how much debt costs and how much you can earn from saving or investing money. Understanding how they work may help you make more informed financial decisions, whether comparing mortgage rates, choosing an investment strategy, or planning for retirement.
Interest is a fee charged for the use of funds that someone else owns. It is a way for lenders to earn a return on the money they lend or deposit. Lenders also need to compensate borrowers for the cost of borrowing, which is a loss of purchasing power over time. The amount of interest paid or earned depends on the time period in which the money is borrowed, the original principal, and the loan terms.
There are two types of interest: simple and compound. Simple interest is calculated as a percentage of the original principal, while compound interest includes both the original principal and the accrued interest. Most lenders today use compound interest calculations for loans and deposits, which are generally quoted as annual percentage rates (APR). This calculator uses a compounding formula to calculate the total interest payable on a loan.
Many factors impact interest rates, including the supply and demand for money and credit. When interest rates are high, it makes borrowing more expensive and can slow economic growth. Low interest rates encourage consumers and businesses to spend and invest, boosting the economy. In addition, the central bank sets benchmark interest rates, which banks then use to determine their own range of APRs.