Interest rates play an important role in your personal finances. They’re what you pay when you borrow money to make a purchase, such as a home mortgage or credit card debt. They’re also what you earn when you save money in a savings account or certificate of deposit (CD). Interest rates are one of the many financial concepts that figure prominently in daily life, and understanding them is crucial to managing your finances.
There are several factors that determine what your interest rate will be when borrowing money, and these usually include your creditworthiness. Banks and other lenders will look at your FICO credit score, banking history and other information to help them decide whether you’re a low-risk or high-risk borrower, and offer you a specific interest rate accordingly.
Another factor that influences interest rates is the overall economy. When the economy is strong, interest rates are typically lower. Conversely, when the economy is slowing down, interest rates will be higher.
When it costs more to borrow, consumers tend to reduce their spending. This can “cool” the economy, reducing inflation and helping the overall economy stay healthy. The Federal Reserve often raises interest rates in an effort to cool the economy by encouraging consumers to save instead of spend their disposable income.
When interest rates are rising, the return on savings and investments like CDs and high-interest savings accounts will also be higher. This encourages people to save their money, which in turn cuts back on demand for goods and services, causing prices to stop increasing as quickly.