Whenever you apply for financing for an item that you aren’t paying for upfront, you agree to pay interest to the institution that’s lending you the money.
Below, you can learn about what are interest rates and why you should care.
What Are Interest Rates?
Interest rates are the percentage of the principal, or loan amount, that a lender charges you in exchange for your use of its funds.
Banks use the deposits that other people make to their checking and savings accounts to fund the loans and in return, you earn interest on the money you place in your own savings account.
How Interest Rates Work
Whenever you borrow money from a lender or credit card company for a purchase, they charge you a fee for the cost of using those funds.
However, you can also avoid paying interest when you pay off a balance in full each month on your credit card. Some interest-free financing promotions waive interest if you pay off the principal balance within a certain time-frame.
Some interest-free financing promotions waive interest if you pay off the principal balance within a certain time frame, such as 24 months.
Common Types of Interest Rates
Banks can charge various types of interest rates and accounts:
- Prime Interest Rates:
- This rate is charged to a banks most creditworthy corporate customers.
- Used as a point of reference for other interest rates, including adjustable-rate mortgages, credit cards, and personal loans
- Fed Interest Rates:
- This interest rate is the rate that banks charge other banks for lending them money from their reserve balances on an overnight basis.
- Mortgage Rates:
- When purchasing real estate you will have either a fixed-rate or adjustable loan.
- Annual Percentage Rates:
- APR describes the interest rate as a yearly amount and includes all other loan-related fees, such as origination and transaction fees.
- Discount Rates:
- The rate the Federal Reserve charges other financial institutions that need to borrow its funds.
- Simple Interest:
- Banks typically use a simple interest formula to calculate the interest on a loan or deposit.
- Compound Interest:
- As opposed to simple interest, compound interest applies to the principal loan amount as well as the interest that has accrued for previous periods.
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Author’s Verdict
Interest rates can really impact your finances.
Hopefully the above information helps you understand whether or not you should pursue a higher yield savings account.
Also be sure to check out our own lists of bank promotions and CD tables!
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