Interest rates are a crucial factor when borrowing money, investing or managing credit. Understanding how they work can help you make better financial decisions, whether you’re securing a loan, building savings or planning for retirement. The exact formulas and calculations used to determine interest rates can vary, with variables such as the type of loan, its duration or whether it’s fixed or variable rate influencing the amount owed or earned.
Higher interest rates often reduce consumer spending, because it costs more to borrow. That may also reduce corporate investment spending, which in turn affects growth expectations and near-term profits for companies that issue high-yielding bonds. However, some sectors and individual companies are insulated from the impact of rising rates because of a time-lag between rate hikes and their effects on consumer and business spending.
Lower rates, on the other hand, stimulate the economy by making it cheaper to borrow money. For example, when the cost of financing a new vehicle drops, more consumers are likely to purchase one, which drives demand for auto parts, hours for factory workers and commissions for salespeople, among other things. The same principle applies to larger investments, such as construction or manufacturing projects.
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