What are interest rates?

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Andrew Goldman

Andrew Goldman has been writing for over 20 years and investing for the past 10 years. He currently writes about personal finance and investing for Wealthsimple. Andrew's past work has been published in The New York Times Magazine, Bloomberg Businessweek, New York Magazine and Wired. Television appearances include NBC's Today show as well as Fox News. Andrew holds a Bachelor of Arts (English) from the University of Texas. He and his wife Robin live in Westport, Connecticut with their two boys and a Bedlington terrier. In his spare time, he hosts “The Originals" podcast.

Interest rates are how much banks will charge borrowers as well as how much they’ll pay to those who deposit money. It might be helpful to think of money you borrow as akin to hiring a car; in the same way you eventually have to return said car, so too do you have to return the amount you borrowed from the bank — called the principal. The interest charged on the principal is a lot like the rate the car hire company charges you for the pleasure of driving their cigarette-smoke fragrant-dog-hair-encrusted saloon. Interest rates — often expressed as APRs, or Annual Percentage Rates (and APRCs for mortgages) — will depend on many factors: how clean your credit history is, thus, how sure a bet you are to pay back your loan — and because of that, riskier borrowers are charged higher rates. Credit cards’ APRs are consistently higher than say, mortgages, largely because of the administrative costs associated with running cards (and consumers’ shocking willingness to be saddled with insurmountable debt tomorrow in order to buy an ace pair of skis today.) Banks always pay lower interest rates on deposits than they charge on loans, because the sliver of percentage rate that divides the two rates is where the bank makes money.

A large factor affecting consumer loan rates is the base rate, a number decided upon eight times a year by The Bank of England, the UK's central bank. People mistakenly assume that there is a direct correlation between consumer interest rates and the base rate. There’s certainly an indirect link since the base rate refers to the interest rate commercial banks must pay on money they borrow from the BoE. The BoE raises rates to counteract inflation by limiting the supply of money circulating in the economy. When the spigot providing money to banks is turned down, and money to loan becomes scarcer. When money is scarcer, you’ll not only have a harder time getting a loan, you’ll be charged more to borrow if you do get one.

Last Updated 29 January 2018

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