Interest rates shape the financial landscape, impacting the cost of borrowing and the return on savings. Whether it’s a mortgage, student loan or credit card, understanding how they work is critical to financial wellness.
Generally, higher interest rates cost more to borrow. That’s because the amount borrowed must cover both the principal and the lender’s risk. Interest rates are often defined as a percentage of the principal and can vary by lender, type of loan, term and other factors.
For example, mortgage loans that are secured by a property typically carry lower interest rates than personal or credit card debts that aren’t guaranteed by any collateral. The reason is that mortgage lenders can foreclose on the property to reduce losses if a borrower stops paying.
Low interest rates stimulate economies because individuals and businesses have access to affordable loans, fueling spending and investment. However, over time, they can also create inflation due to a buildup of excess demand and corresponding price increases.
Similarly, high interest rates can suppress consumer spending and business investment, slowing economic expansion. Over time, persistently high interest rates can lead to stagnant wages and higher unemployment as businesses cut back on hiring.