Interest rates play a critical role in our financial system and the economy. They encourage us to spend money, invest it, and save it. Understanding them can help you make better financial decisions.
There are many factors that influence interest rates, from supply and demand to inflation and government monetary policy. But the most important factor is the credit risk of the borrower. The higher the risk, the more expensive it is to borrow money.
For example, mortgage loans are typically less risky for lenders than credit card debt because the lender can seize the property if the borrower doesn’t pay back the loan. That’s why they often have lower interest rates than personal loan debt.
A borrower’s credit history and the type of loan also affect their interest rate. The type of loan can be fixed or variable. The former is more predictable and makes budgeting easier because the payment will stay the same for the entire loan term. The variable rate, on the other hand, can fluctuate over time and may be harder to budget for because it can go up or down.
Another factor that influences interest rates is the amount of debt a business or individual has, which is called the debt-to-asset ratio. The larger this ratio, the more likely it is that a business or individual will default on the debt. That’s why it’s important to keep track of your debt-to-asset ratio and monitor interest rates.