Understanding Interest Rates

by Anza Goodbar
(last updated November 22, 2011)

Simply put, interest rates are the cost of borrowing money. In order to lend money, the lender must set aside funds for someone else's use. Interest is the amount of money agreed upon to pay back the loan. Borrowing money allows for purchases to be made now and paid for over time. Interest rates are tied to the risk factor a lender has in making the loan, the longer your credit history and the higher your score, the lower the interest rate. Interest is the revenue companies get for lending their product, or money.

Interest is also the money paid to you on money you deposit at a financial institution. Simple interest is typically paid on a basic savings account. Simple interest can be calculated by multiplying the principal times the interest rate times the time period the interest is to be paid. For example if you took out a loan for $100 at 5% interest with intent of paying it back in year, you would multiply 100 x .05 x 1 for a total of $5.

Some types of interest compound over time. This simply means that you make interest on your interest, not just the principal amount you deposited. In general you will make more money on funds that are compounded more frequently. The APY or annual percentage yield shows you what you are actually making on your money. If you are purchasing a CD, and they both pay the same interest, see which one pays out interest most often, it will be the better choice for you. The calculation for APY on investments can be tricky, talk to your financial advisor for more detailed information.

When shopping for a loan, know your credit score. That is your bargaining chip for getting the best rate possible. As you can see, the higher the interest rate, the more costly it is to borrow money. The lower your credit scores the higher risk you are to a lending institution. Over the course of a 30 year mortgage a higher interest rate could cost tens of thousands of dollars.

Just as a lending institution wants to make as much money from a financial transaction, you should be equally savvy when looking for interest rates paid out to you for deposits and CDs. Interest rates can make you money as a depositor or cost you money as a borrower.

Author Bio

Anza Goodbar

Anza is a single mother of four who makes her home in Colorado. She enjoys writing, hiking and is an avid football and hockey fan. She is the owner of a virtual business services company; writing is just one of the many services her company offers. ...

MORE FROM ANZA

Repairing Expanded Earlobes

Earlobes can expand from wearing heavy earrings or from stretching them out intentionally by gouging the ear. Over-stretched ...

Discover More

What is a Silverfish?

Silverfish are small nocturnal insects that thrive in humid environments. They thrive on eating sugars and starches found in ...

Discover More

North Woods Wild Rice Soup

Winter soups are great on a snowy cold day. This soup is a wonderful addition to your winter soup collection.

Discover More
More Money Tips

Loan Consolidation

If you have gone to college, are thinking of going to college, or simply owe quite a bit of money, then chances are you have ...

Discover More

School Loan Consolidation

Student loans can be expensive to repay. Depending on the types of loans you have, a consolidated program could help make ...

Discover More

Using a Home Equity Line of Credit to Pay for Christmas

It has become increasingly popular to use the equity in a home as a "magic bullet" for solving any and all financial ...

Discover More
Comments

If you would like to add an image to your comment (not an avatar, but an image to help in making the point of your comment), include the characters [{fig}] in your comment text. You’ll be prompted to upload your image when you submit the comment. Images larger than 600px wide or 1000px tall will be reduced. Up to three images may be included in a comment. All images are subject to review. Commenting privileges may be curtailed if inappropriate images are posted.

What is three more than 8?

There are currently no comments for this tip. (Be the first to leave your comment—just use the simple form above!)


Videos

Subscribe to the Tips.Net channel:

Visit the Tips.Net channel on YouTube