An interest rate is the cost of borrowing money or the return you earn on savings/investments, expressed as a percentage of the total amount.
Basic Definition
Interest rate = the percentage charged by a lender to a borrower for the use of money.
It applies to:
- Loans (mortgages, car loans, personal loans, etc.)
- Credit cards
- Savings accounts
- Bonds and investments
How It Works
- If you borrow: You pay interest on the loan.
- Example: A $10,000 loan at 5% annual interest means you pay $500/year in interest.
- If you save/invest: You earn interest on your money.
- Example: A $10,000 savings deposit at 4% interest gives you $400/year in return.
Types of Interest Rates
| Type |
Description |
| Nominal |
Stated rate (not adjusted for inflation) |
| Real |
Adjusted for inflation (true value) |
| Fixed |
Stays the same for the term of the loan |
| Variable (Floating) |
Changes based on market rates (e.g. prime rate) |
| APR (Annual Percentage Rate) |
Includes fees and other costs |
| APY (Annual Percentage Yield) |
Reflects compounding on savings |
Who Sets Interest Rates?
- Central Banks (like the Federal Reserve, Reserve Bank of Australia, or Bank of Canada)
- Set benchmark interest rates (e.g. the Fed Funds Rate)
- These influence all other interest rates in the economy
- Banks and lenders
- Set rates based on central bank rates + risk + profit margin
Why Interest Rates Matter
| When Rates Are Low |
When Rates Are High |
| Cheaper to borrow (loans, mortgages) |
Loans cost more (higher payments) |
| Encourages spending & investing |
Encourages saving, slows borrowing |
| Can boost economic growth |
Helps control inflation |
| Lower returns on savings |
Higher returns on savings |
Example: Interest Rate Impact
| Loan Amount |
Interest Rate |
Annual Interest |
Monthly Payment (approx) |
| $20,000 |
5% |
$1,000 |
~$377 |
| $20,000 |
10% |
$2,000 |
~$425 |
Current Global Context (2025)
- Central banks in many countries are adjusting rates to combat inflation or stimulate growth
- Interest rates can vary greatly by country, currency, and economic conditions
Summary
| Key Point |
Explanation |
| Interest rate |
Cost of borrowing / reward for saving |
| Set by |
Central banks + lenders |
| Affects |
Loans, credit cards, mortgages, savings |
| Low rates = |
Cheap borrowing, slow savings growth |
| High rates = |
Expensive borrowing, better savings returns |