Interest rate is a crucial financial metric that represents the price a borrower pays or the compensation earned for using someone else’s money. It’s applied over a set period, known as the loan or investment term, and can vary by lender and borrower.
The rate may be a fixed percentage or variable and can be expressed daily, weekly, monthly, quarterly or annually. When the terms of a loan or investment are determined, three factors determine total interest: principal sum, compounding frequency and length of time. The more often interest compounds during a term, the faster and more total interest is earned. Most formal interest payment calculations today use compounding and thus, all references to interest rates on this website will be for compounding interests unless otherwise specified.
In general, loans and debts with more collateral or security (such as mortgages) have lower interest rates than those that don’t have this protection. This is because a lender can take possession of the underlying asset and sell it to recoup its losses in case a borrower defaults.
Economic growth typically increases as interest rates fall, because individuals and businesses are more willing to spend and invest. However, this can lead to market disequilibrium and inflation as demand exceeds supply, and is why many governments attempt to control interest rates. To do this, they set benchmark interest rates for banks and financial institutions to follow. These rates are then based on a variety of factors, including inflation and other key macroeconomic indicators, to maintain stability in the financial markets.
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