If there is one thing in the world of finance that is both simple and confusing to understand at the same time, then it has got to be interest rates. The reason for this is described in greater detail below, but simply put interest rates are a percentage that is applied to a specific amount of money, for a variety of reasons. These reasons can be as simple as what a bank pays their clients to store their money with them, or what a lender charges a borrower in order to obtain a loan.
- What are interest rates? The simple explanation of interest rates has already been explained, the more detailed explanation is a tad more confusing. This is in large part due to the difference in what most people consider to be interest rates, and what financial institutions and even governments consider interest rates. When most people talk about interest rates, they typically think about things like the interest rate at the local bank, which is considered a nominal interest rate. A nominal interest rate is a type of interest rate that doesn't consider things like inflation. When financial institutions and governments talk about interest rates, they talk about real interest rates. These are the types of interest rates that include things like inflation, and how the market often changes.
- Different types. As you have already learned, there are at least two different types of interest rates that can affect most people. However, there are literally hundreds of different types out there. For example, think about all the different ways that people can borrow money. Each of these loans includes an interest rate that can (and will) be applied to the principle of the loan. For example, the interest rate on a home loan is not going to be the same as one on a car loan, or even one that is offered by a credit card company. Furthermore, each of these interest rates are different from what you earn on your savings account, or CD, and so on.
- Is there a limit on them? While there is theoretically no limit on how low an interest rate could go, in the real world there really is a practical limit to both how lot and how high an interest rate can go. Lenders need to make money off of what they loan out, or they will soon run out of money themselves. Furthermore, the government takes a really dim view to interest rates that go too high, since they can easily be considered predatory and harmful to the general economy.