When you get a mortgage or credit card, the company you choose to lend money to will often set your interest rate based on personal factors such as your FICO credit score and bank statements. However, the overall state of the economy and a country’s central bank (the Federal Reserve in the United States) also influence the interest rates that lenders charge consumers.
In general, higher interest rates make it more expensive for people to borrow and spend money, and lower ones do the opposite. This has a direct impact on the buying power of every dollar in your bank account or in investments like stocks, bonds and real estate.
Understanding what exactly makes up the total price of a loan or credit card can be complicated, and the exact formula is dependent on how long you plan to pay back the debt and whether the interest is fixed or variable (meaning it may change over time). Generally, though, there are two main parts to the total: principal and interest. If Derek borrows $100, for example, he will owe the bank $110 one year later: $100 for the original principal and $10 as interest.
When the Federal Reserve raises rates, for instance, it is meant to slow down borrowing and spending by consumers and businesses, which can lead to overheating or inflationary economic conditions. Meanwhile, banks may also increase their deposit rates to attract new customers and retain existing ones.