Financial literacy is a problem among the public and specifically in some communities. A survey in 2016 found that only 42% of Americans could pass a financial literacy test.
That’s not surprising, though, considering that most people don’t know much about personal finance, money management, and investing.
Fortunately, knowledge is power. The more you understand about your personal finances and financial instruments like interest rates, the better able you are to make informed decisions about your money and plan.
This guide will explain everything you need to know about interest rates so you can make smart decisions going forward.
What is an Interest Rate?
Interest rates are what people and businesses pay to borrow money.
When someone loans you money, they are giving you a benefit: by giving you the money, they incur no additional cost.
To compensate the person or company that is loaning you money and bearing this cost, you pay interest.
Interest is like rent; you pay a fee to use someone’s money. The amount of interest you pay is based on the size of the amount borrowed. The more money borrowed, the more interest you are likely to pay.
When you deposit money in a bank account, you give the bank permission to use it to make loans to other people. When you deposit money in a current (checking) or savings account you are lending money to the bank.
The bank is then responsible for paying you a return on the money you’ve loaned them.
You can calculate the interest rate you earn by dividing the annual percentage yield (APY) by one plus the annual percentage rate (APR).
Deciphering Financial Language: Defining APR, APY, and Effective Rate
Annual percentage rate (APR) – The interest rate you would receive if you were to take out a loan. The annual percentage rate is the amount of interest you would pay per year on a loan.
APR or Simple Interest Rate is calculated as follow: Principal amount x interest rate x time.
Annual percentage yield (APY) – The amount of interest you would earn if you deposited money in a savings account. The annual percentage yield is the amount of interest you would earn on a savings account.
The Annual Percentage Yield can also be called Compound Interest Rate mostly advertised by Investment banks. However, some lenders are now practicing this interest calculation on loans or credit cards.
Compound Interest is also called interest on interest, it is advantageous on savings account, but will lead the borrower to pay even more on interest.
Effective interest rate – The annual percentage rate minus the terms of the deal. The effective interest rate is the interest rate you actually pay after all terms are factored in. If you see an interest rate advertised, you might see two numbers: an annual percentage rate (APR) and an annual percentage yield (APY). These are two ways of expressing the same interest rate. It’s important to understand what these numbers mean and how they’re calculated.
When Are Interest Rates Important?
Interest rates are important whenever you’re thinking about taking out a loan or loaning someone money. When you take out a loan or make a deposit, the interest rate is an important factor.
The interest rate determines how much money you get back and how much money you pay in fees. When you’re trying to decide which type of loan to take out – a mortgage, car loan, or personal loan.
The interest rate will help you decide which one is best. If you’re trying to decide which type of account to open – a savings account, a current account, or a CD – the interest rate will help you decide which one is best.
How Do Interest Rates Work?
The interest rate is how much money you’re charged each month. The interest rate is the same for any two or three-month period. But it’s important to understand that the interest rate changes every month. When you go on a new credit card, for example, the interest rate will change from month to month and year to year. That’s because each credit card has a different set of terms and fees.
Why Are Interest Rates Increasing?
Interest rates have a direct correlation with the economy. When the economy is doing well, interest rates tend to go up. When the economy is doing poorly, interest rates go down. There are two major factors that affect interest rates: inflation and monetary policies. Inflation occurs when the demand of goods and services in the economy exceeds the supply for those same goods and services.
When this happens, the value of the currency declines. Most central banks use interest rates to control inflation: when inflation is high, they raise interest rates; when inflation is low, they lower the interest rates.
Higher interest rates encourage people to save their money by making it less desirable to take out loans.
Central banks and The Federal Reserve (US) have two main purposes: stabilise interest rates and prevent inflation; and also manage the monetary base, or the amount of money in circulation, so that its members can keep up with economic growth.
How Can You Protect Yourself?
If you’re in the market for a home, you need an honest and trustworthy attorney who will help you understand your rights and protect yourself from predatory lending practices. You should contact an attorney who specializes in residential property law if you have any questions about your rights under your state or country law.
How Will Higher Interest Rates Affect You?
When interest rates are low, it’s more appealing to take out loans and invest in risky assets. When interest rates go up, it becomes more expensive to borrow money to buy a house, car, or start a new business. It also becomes less appealing to take out risky loans since the interest rates are higher.
When the interest rate is raised, it increases the cost of borrowing money. This can lead to higher debt levels, which can then be difficult to refinance or sell. When it comes to buying homes, a mortgage is considered a risky loan that can lead to higher debt levels if the borrower doesn’t pay on time or fails to make good on their payments. If the home is worth less than $300,000, then it will cost more than $1 million to refinance a house loan.
Strategies to Survive Rising Interest Rates
Now that you understand how interest rates work and how they’re connected to the economy, it’s important to make sure you are prepared in case interest rates rise even more.
Stay Current on Your Debt – If you have credit card debt, student loans, or a mortgage, make sure to pay it off as quickly as possible. The less debt you have, the less you have to worry about paying interest rates.
Start Saving – The more money you have saved in your emergency fund and the more money you have in your retirement account, the less you must worry about rising interest rates.
As interest rates rise, it’s a good idea to reevaluate all of your financial accounts to make sure you’re still getting the best interest rates possible. – Keep an Eye on Your Savings – Make sure that you’re not spending too much money when it comes to saving.
If you’re spending too much, you’ll be in a better position to pay off your debt when interest rates rise.
How To Get Out Of Debt?
You might think that getting out of debt would be easy and simple, but it takes more than just asking for help. You have to take action and make the decision yourself. You have the ability to do this because you have access to financial resources and the ability to choose how you want your life to change from now on.
If you don’t ever plan on being in debt, then there is no reason why you shouldn’t start taking steps now toward freeing yourself from it all together.
Final Thoughts
Interest rates are an important factor in personal finance and financial decisions.
While interest rates have been rising since the financial crisis in 2008, they are expected to rise even more rapidly in the near future, which means that those with debt will have to pay more to service their loans.
It’s important to understand the factors that affect interest rates so that you can prepare for rising interest rates and make sure you’re paying the lowest rate possible.
Once you understand the factors that impact interest rates, you can make a decision about what to do about your debt. You can either take steps to reduce your debt and save money or you can choose to completely eliminate it. It’s important to decide whether or not you want to eliminate all of your debt or whether you want to try and work on reducing it.
There are many factors that impact interest rates and how they affect an individual’s financial situation, but it is always important to understand the overall trends in terms of interest rates. This will help you make an informed decision about how best to handle your finances so that you don’t end up with more debt than necessary.
