Are you confused when you read news headlines about interest rates? You're not alone - even if it seems like everyone else understands, chances are they have spent at least a few moments asking themselves the same question: what do interest rates mean, anyway? Interest rate basics can be confusing and take some time to unpack, but don't worry - understanding the fundamentals of how our economy works starts with understanding interest rates. In this blog post, William Schantz goes over exactly what an interest rate is, why it matters for your bank account and other financial decisions, and more!
Interest rates represent the cost of borrowing money. According to William Schantz, banks and other financial institutions charge borrowers a certain percentage rate on loans, which is known as the interest rate. For example, if you take out a loan for $10,000 at an interest rate of 10%, then you are required to pay back $11,000 over the life of the loan - the extra thousand is your interest payment.
The interest rate charged by financial institutions reflects both the cost of borrowing money and its attractiveness to lenders. When credit markets tighten, meaning that fewer people are able to borrow money from banks, those who do can expect to be charged higher interest rates. On the other hand, when credit markets loosen up, and more people are able to borrow money, the interest rates tend to decrease.
Interest rates are also closely tied to inflation and other economic indicators, such as GDP growth. When inflation is high, it typically signals a strong economy where businesses and consumers have more money to spend - this, in turn, pushes up demand for loans and can cause interest rates to rise. Conversely, when inflation is low, it usually means that an economy is slowing down, which can lead to lower interest rates as lenders become less willing to take on riskier borrowers.
In addition, central banks, as per William Schantz, play a role in setting interest rates by influencing the money supply. For example, when central banks lower the cost of borrowing money through quantitative easing, they indirectly influence the market’s interest rate by making it cheaper for businesses and consumers to borrow money.
Interest rates are a key tool used by governments, central banks, and other financial institutions to influence the economy. According to William Schantz, they represent the cost of borrowing money - when interest rates are low, it is generally cheaper for people to borrow money from banks or other lenders, which can lead to increased spending and economic growth. On the other hand, when interest rates are high, fewer people are able to afford loans which can slow down economic activity. Understanding how interest rates work is an important part of managing your finances and making smart investment decisions.
