Interest rates play a big part in your day-to-day finances. Whether you are paying a loan or saving money for the future, your interest rate determines how much you spend and how much you earn. Understanding how it works can help you make smarter financial decisions.
The most important things to know about interest are that it is a percentage of the principal sum and that it compounds over time. The more frequently your interest compounded, the faster it will grow. It is a key concept to understand when evaluating different loans and savings options.
Many people use annual percentage rates, or APRs, when talking about home or auto financing. These are similar to interest rates, but they take additional fees into account to give you a more complete picture of the cost or return on your investment. For example, some administrative fees such as title insurance and registration are often rolled into the loan or finance agreement.
A good rule of thumb is that the lower your interest rate, the better. High interest rates can make it more expensive to borrow, which may slow economic activity, while low rates can encourage borrowing and spending. Borrowers can minimize their rates by researching and shopping around for the best deals. They can also choose to borrow at opportune moments when economic factors are favorable.
Savers and savers can also minimize their rates by looking for higher APYs (annual percentage yields). For example, depositing $1,000 into a bank savings account with a 1% APY will earn you 10 cents of interest over one year.