BBC Content Team
What is Interest Rate and How Does it Work?
To first know about what Interest Rate is, we first need to know what interest is. What is interest, and how can it be used? Interest is the percentage of a loan or deposit balance paid to the lender periodically for using their money. How much you pay or earn is dependent on the interest rate, how long it takes to repay, and how much the loan is. What is interest rate, though? Since interest rate is also an important part of paying interest, how does it work and what is it?
First off, interest rate is the percentage of the amount of money lent charged by the lender for the use of its money. As a result, banks pay you an interest rate on deposits because they are borrowing the money from you. The bank applies the interest rate to the total unpaid portion of loans or the credit card balance. All interest rates are not the same. If the bank thinks that a loan cannot be repaid, or there is a very little chance of it, they will charge higher interest rates. Usually, that is the case with credit cards. Credit card loans are very expensive to pay off. That is why banks charge more for those kind of loans so that they can get more money. That is why it is important to check the credit score and how to improve the credit score. The higher the score, the lower the interest you have to pay.
To calculate interest rate, you have to divide the interest by the amount before interest times the time of the loan. If you can calculate the interest rate, you will know the amount of interest you have to pay in the duration of the how much the loan is that you are paying for.
A country’s central bank sets interest rates. The federal funds that banks charge each other for overnight loans really affects the economy. They have to maintain 10 percent of total deposits in reserve each night. If they do not do that, they would have to lend out every single penny they have. If they do that, then the banks will have no money to give in interest. This will then make people mad because they want the money from the interest they are getting from the bank. The higher the interest rate, less people will be able to pay the interest, which makes it harder for people to fund purchases. This also makes the people save money. High-interest rates also makes capital low for businesses, strangling supply.
The opposite goes for low-interest rate. Savings rates fall. People make more riskier, but profitable decisions to investments. Low interest rates drives up stock prices. This also makes business loans more affordable. This lets businesses expand and new jobs. Low-interest rates also decreases housing prices and mortgage costs.
Interest rates really affect how much people will pay in interest and how much people will earn. It really affects the economy and how it will grow. As you can see, interest rates are really important in the world today.
Amadeo, Kimberly. “How Interest Rates Work.” The Balance, The Balance, 15 Aug. 2019, www.thebalance.com/what-are-interest-rates-and-how-do-they-work-3305855.
Person, and wikiHow. “How to Calculate Interest Rate.” WikiHow, WikiHow, 7 May 2019, www.wikihow.com/Calculate-Interest-Rate.