Interest rates are at the center of many of the decisions we make regarding how much to borrow, when and from whom, and whether or not to invest. Understanding how it all works can help you gain control over your financial health, from the price of a car loan or mortgage to the growth of savings accounts and retirement funds.
There are many factors that influence interest rates. They can be macroeconomic, like inflation and economic stability, or personal, such as an individual’s creditworthiness and their ability to repay debt. Individuals also have the power to affect their own interest rate, through diligent budgeting and saving habits.
Inflation is one of the biggest influences on interest rates, as it directly affects how much a person will pay for goods and services. When inflation is high, interest rates are typically higher to curb spending and prevent deflation, while when it’s low, rates are lower to stimulate borrowing and economic activity.
Other factors that influence interest rates include the risk an entity perceives when lending money, the cost of taxes and the liquidity preference — which is people’s desire to have their resources available in cash rather than in an asset that takes time to realize the full benefit of. Finally, individuals can influence their interest rates through a healthy credit score and the use of savings tools that help them earn real interest on their deposit balances.
Ultimately, the most important factor is supply and demand. If there’s a lot of demand for credit or money, then interest rates are higher, and when demand is low, rates are lower to attract more lenders.
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