Why are interest rates important?
In the modern financial landscape, interest rates play a huge role for all of us. On the investment side of your financial portfolio, the interest rates attached to your investments will determine how much money you make from those investments.
Interest rates are also seen used in borrowing and lending money. The interest rate of a loan represents the amount of money the lender charges the borrower in order to borrow money.
Whether you’re investing, borrowing, or simply saving, having a good understanding of the role interest rates play in your life is immensely helpful. When investing, look for high interest rates. When borrowing, you’ll want as low of interest rates as possible.
How does the interest rate calculator help me?
The interest rate calculator above makes it easy to determine how much you can make in interest with a certain investment. It also makes it easy to figure out how much interest you will have to pay for a specific lending situation.
All you have to do is input the details of your investment, click “enter,” and you can see how different interest rates will impact your long-term financial goals.
Can interest rates change?
Interest rates change all the time. Changing interest rates have been a hot topic, often discussed as a way to combat record-high levels of inflation. In the United States, the Federal Reserve sets interest rates for borrowing money. When interest rates go up, it becomes more expensive for banks to borrow money, and that cost then gets passed down to individuals.
Rising interest rates can make it more expensive to take out a mortgage, use your credit card, and get loans for things like vehicles and boats. If you save a lot of your money in a high-yield savings account, rising interest rates are great news. This means that the money you earn by putting funds into your account will go up.
On the investment side, the Federal Reserve’s policy will not play as large of a role. However, rising interest rates tend to wreak havoc on the stock market because it costs more money for businesses to do business, cutting into revenue numbers and decreasing stock prices.
What factors influence an interest rate?
There are many factors, both factors that are in your control and factors that are out of your control, that will impact the interest rates you experience.
Factors outside your control:
- Rates set by the Federal Reserve
- Economic activity
- Unemployment metrics
Factors within your control:
- Credit score
- Borrowing history
What is investment interest?
When you make an investment, whether it’s in a specific stock or a different type of fund, you’ll see an interest rate associated with that investment. When you own that asset, you’ll earn interest for the lifetime of your ownership. For instance, if you make an investment that has an interest rate of 4%, you’ll get paid 4% of the value of your investment.
What is the difference between an interest rate and APY?
Interest rates and the annual percentage yield (APY) of an investment are often seen as the same thing, but that’s not the case. While the two are very similar, there is a difference that can have a big impact.
A raw interest rate does not take into account compounding interest. Annual percentage yield, on the other hand, is the interest rate of an investment that considers how often the interest compounds. APY will usually be slightly higher than the simple interest rate.
Is simple interest different than compound interest?
No, the two are different. For investors, compounding interest is always better than simple interest. Simple interest only applies the interest rate to the principal value of the investment. Compounding interest is applied to the principal amount plus any gains interest gains from prior years.
If you make an investment of $100 into an asset that has an interest rate of 5%, simple interest will pay you 5% of $100 each year, which is $5. Compounding interest will pay you 5% of $100 the first year, then 5% of $105 the second year. Over time, your investment will build much faster with compound interest.
Does the Federal Reserve influence interest rates?
The Federal Reserve sets the Federal Funds Rate which is a baseline rate that dictates how much it will cost to borrow money. For many years, the Federal Funds Rate has been at 0% as the government tried to stimulate the economy.
Now, the government is trying to curb inflation and slow down economic activity, so the Federal Funds Rate is now over 2%. This rate makes it more expensive for businesses and banks to borrow money. Institutions then pass that cost to consumers by increasing interest rates for individuals to borrow money.