Interest rates affect every aspect of our financial lives, from the amount we pay on loans to how much money we can earn in savings accounts. Understanding how interest rates work can help you take control of your finances. This article helps you understand what interest is, how it is calculated, and why the rate you are charged or earning can vary so much between different lenders.
Interest is the price you pay to borrow money, and is often expressed as a percentage of the principal (the original amount borrowed). Lenders charge or earn interest in order to make a profit, or to compensate them for taking on the risk of lending or investing. The higher the risk, the higher the interest rate. Ultimately, the amount of interest paid or earned depends on the market for credit and investment, with demand driving up or down rates based on economic trends. The market for credit also influences individual factors such as your credit score, financial history and other personal characteristics. Whether you are shopping for an auto loan, home mortgage or credit card, interest rates are an unavoidable part of the transaction. However, understanding how to calculate interest can help you comparison shop for the best deal and be more financially savvy in making borrowing decisions.