Interest rates can be confusing, but they’re important to understand when you borrow or save. A key component of the economy, they influence borrowing costs for consumers and businesses, as well as the earnings on savings or investments.
Borrowing Costs: When interest rates are high, it becomes more expensive to borrow money for a mortgage, auto loan or credit card. When this happens, it typically limits consumer spending and can slow the economy. Conversely, low interest rates make it easier for borrowers to access loans and encourage spending. However, these periods of economic stimulus can lead to market disequilibrium as demand exceeds supply, resulting in inflation.
Savings and Investments: When interest rates are low, it’s easy for individuals to earn more on their savings in banks, credit unions, certificate of deposits (CDs) or other money market accounts. But as rates rise, it can become more difficult for people to earn enough on their savings to offset higher loan and credit card payments. Ultimately, it may be necessary to save less during this time, which is one of the goals of the Federal Reserve when it raises rates.
Interest rates can be measured in several ways, including nominal and real interest rates. Nominal interest rates don’t take inflation into account, while real interest rates do. The latter is also known as the Fisher equation and reflects the buying power of the principal that was borrowed, lent or invested, over time.
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