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Understanding What Are Interest Rates And How They Work
ne form of interest appliances and cars.
familiar to most of us is
on our credit card Interest rates vary. You may have
purchases. We are charged a a fixed rate of interest. This
monthly interest rate on our where the lender sets the rate of
unpaid balances. If you spend interest when the loan is made.
$100, you will be charged The rate never changes over the
interest each month for the length of the loan. If you
portion of the original loan borrow, $100, you agree to repay
remaining. If you pay $20 on the $100 plus interest, 10% for
loan in the first month, you will example, over a fixed period of
reduce the loan to $80. The next time. The total amount of the
month, however, you will have to loan would then be $100 plus 10%
repay $80 plus the monthly interest or $110.
interest.
There are also variable interest
The Federal Reserve Bank sets the rates. Here you agree to repay a
interest rates. These are raised loan, but the interest rate is
when the economy is “heating up.” subject to change and the amount
This has the affect of decreasing of interest is calculated on the
consumer spending by adding monthly balance. If you borrow
greater interest to financed the same $100, you will owe $100
purchases. When the economy the first month. You pay $10. In
begins to slow down, interest the next month you will owe the
rates may be lowered by the remaining amount of the bill,
Federal Reserve Bank to increase $90, plus the interest for that
consumer spending. With lowered month, 10% for example. In
rates, consumers tend to use effect, you will now owe $99,
their credit cards more often and despite the fact that you have
finance more purchases of major paid $10 against your loan. If
you repeat your payment of $10 one year ($110), the bank might
the following month, you will now give you an interest rate of 8%
owe $89 plus 10% or $97.9. You over two years, costing you $116.
can see that after paying $20 on While $6 interest may not seem
your loan, you have only lowered like much, you can imagine what
the amount by $2.10. This is why the interest would be if the loan
you should not keep high balances was for $1,000 or $100,000.
in variable rate accounts.
There is also interest paid on
The lender sets the rates for investments. One of the most
your loan. This is because he/she common forms of investment is a
sees you as a risk. Interest savings account. Here interest is
rates depend on your credit calculated on the amount of money
history. If you have good credit, you invest and how long you leave
the interest may be lowered. If it untouched. If, instead of
you have bad credit, then the borrowing $100, you put it into a
risk is greater and your interest savings account and left it there
rate is going to be higher. for one year, you will have $100
Lenders can quickly learn your plus the bank’s interest rate. If
credit history by looking at your the bank paid 5% interest, you
credit report. would have $105 at the end of the
year. If you left the money in
The length of the loan affects the bank for another year, you
your interest. Financial would have $105 plus 5% interest
institutions are likely to offer or $110.25. The more money you
you lower interest rates if you place into a savings account, the
obtain a loan with a longer greater the amount of interest
repayment time. Instead of the bank will have to pay you.
repaying your $100 plus 10% over
About the Author:
Read more from Joe Goertz at: finance-mag.com
Read more articles by: Joe Goertz
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