Whenever you open a bank account or a retirement account, or when you’re applying for a loan for a home, car, or business, you wind up dealing with interest rates. What is interest, and what does it mean for you? Knowing more about interest rates and how they work will help you make wise decisions when saving and borrowing money.
Why Interest Rates are Important
What is Interest?
There are two ways interest can affect you. One way is it is given to you as the result of having an account with a bank or credit union. Interest is also added to expected payments required by a lending organization.
First, let’s consider interest when it is given to you. When you put your money into savings accounts or checking accounts, it’s easy to think of those dollars as simply sitting in a dark bank vault. But, the exact opposite is true. Once you hand your money over to a bank, they then use your money for investments. The bank makes these investments in order to gain profit for both them, their shareholders, and, yes, you. The money they get back from their investments is returned to you as a small percentage of interest on your deposit. Think of the interest rate on your accounts as a “Thank you.”
On the flipside, interest is added to any payments you make when you borrow money from a financial institution or certified lender. Here it acts as the lender’s fee and a guarantee for their services. This is how financial institutions make money, aside from investments, ensuring they remain solvent.
Are All Interest Rates the Same?
Keep in mind that no two interest rates are alike. Applying for the same size loan at different financial institutions can offer up varying interest rates.
Who sets these interest rates and how? Two parties are responsible.
The first group is the Federal Reserve, often called The Fed. They set monetary policy that dictates the borrowing and lending practices of banks and other financial groups.
Based on these policies, financial institutions attach extra rates to compete with other lenders and appeal to borrowers. These interest rates fluctuate based on the loan product, loan-to-value, and the overall credit of the borrower. All these considerations result in the final loan product offered and influence the interest paid to your checking and savings accounts.
How Do Interest Rates Affect You?
When you make a significant purchase, like a house or a car, you probably don’t have enough cash on hand to buy it outright. If you’re like most people, you’ll have to finance the purchase by taking out a loan and paying it off over multiple months. Those loans will come with interest rates that you need to account for.
When borrowing money, make sure you consult a number of banks and lenders because you might be able to find a more competitive rate if you check more than one place. Many banks and credit unions feature a helpful loan calculator on their websites, so you can see how much your monthly payment would be before you visit their establishments.
Don’t Be Afraid to Ask Questions About Interest Rates
As we’ve said, no two interest rates are alike. You’ll want to pay attention to the news because economic trends often prompt the Fed to adjust rates.
To fully understand the interest rates that are being applied to your savings account or loan application, don’t be afraid to ask questions. When it comes to your money, it is your right to know how interest rates will affect it. If you still need help filling in the gaps, you know where to find us.