Interest rates are a critical concept that affect how much it costs to borrow money or earn from savings and investments. They are also a factor that determines the quality of a loan, and can even be a factor in the selection of a car or home. While a loan’s interest rate is set by the lender, there are many different factors that influence it.
Interest is the compensation that lenders receive for taking on the risk of lending money to others. It is calculated as a percentage of the principal, and is typically applied to debt over a specified period of time, such as a year. It is sometimes referred to as the cost of debt or rate of return, and can be expressed as annual percentage rate (APR) for loans and credit cards, or as effective annual percentage yield (APY) for savings products like savings accounts and Certificates of Deposit (CDs) at banks and credit unions.
A variety of factors impact interest rates, including supply and demand for loans, government monetary policy, inflation, and economic conditions. In particular, when demand for money and credit is high, interest rates are generally higher than when demand is low.
In addition to these external factors, individual lenders take personal considerations into account when setting interest rates. Those factors include your creditworthiness as determined by your FICO score and bank statements, and your ability to repay your debt. Lenders may also consider the liquidity preference of customers, meaning their desire to have their funds available in a form that can be immediately exchanged, as well as tax considerations.