An interest rate is the percentage charged by a lender to a borrower for the use of money, or the percentage paid by a financial institution to a depositor for holding their money. Interest rates are set by market forces and influenced heavily by the Federal Reserve's federal funds rate. They affect everything from mortgage payments and credit card costs to savings account yields and bond prices. Interest rates are one of the most important variables in personal finance and the broader economy.
Interest Rate
Definition
An interest rate is the percentage charged by a lender to a borrower for the use of money, or the percentage paid by a financial institution to a depositor for holding their money. Interest rates are set by market forces and influenced heavily by the Federal Reserve's federal funds rate. They affect everything from mortgage payments and credit card costs to savings account yields and bond prices. Interest rates are one of the most important variables in personal finance and the broader economy.
Example
The Federal Reserve raises its benchmark rate from 4.5% to 5.0%. As a result: mortgage rates increase from 6.5% to 7.0% (adding ~$200/month to a $400,000 mortgage), savings account APYs rise from 4.5% to 5.0% (earning an extra $50/year per $10,000 saved), and bond prices decline as new bonds offer higher yields.
Key Points
- 1The Federal Reserve's federal funds rate influences all other interest rates
- 2Higher rates increase borrowing costs but improve savings returns
- 3Fixed rates stay the same; variable rates change with market conditions
- 4Real interest rate = nominal rate minus inflation rate