Interest rates are a crucial part of the financial system, impacting both how we spend our money and how we save it. Understanding how interest rates work and what affects them is essential for individuals who want to improve their financial literacy and make the best decisions about their money.
An interest rate is a specific percentage of the amount borrowed or deposited, expressed as a fraction of the principal sum over an agreed-upon period of time, usually a year (known as a term). It can refer to the charge that lenders or banks impose on borrowers when they take out a loan, such as an annual percentage rate or APR, or it can refer to the amount of money earned by depositors and investors from bank accounts such as savings accounts or certificates of deposits, known as an annual percentage yield or APY.
There are a variety of factors that influence interest rates, from the types of debt to personal variables such as a person’s creditworthiness. The type of debt a person has also impacts the interest rate, with mortgage loans often having lower rates than personal loans or credit card debt. The reason is that a mortgage loan is secured by collateral, which can be used to reduce a lender’s losses if the borrower fails to repay.
The most important factor that determines a person’s interest rate is their creditworthiness, assessed by looking at their credit score and other financial documents. Individuals can improve their chances of accessing the best interest rates by working on improving their credit scores and limiting their debt.
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