Interest is what a lender charges you to borrow money. It is usually expressed as a percentage of the amount borrowed, known as the interest rate. You might often see this referred to as an annual percentage rate, or APR, which is the interest rate (plus certain fees) you would pay over one year.
When you borrow money, the amount you receive is called the principal. And when you pay back the loan, you repay the principal plus interest. The interest rate determines how much interest you pay.
Borrowing money with higher interest costs more money, while loaning or investing money with higher interest earns more money. That’s why a high interest rate is good for lenders but bad for borrowers.
Lenders typically charge interest rates on any kind of borrowed or owed money, including:
The Federal Reserve Board of Governors (the Fed), the U.S. central bank, influences interest rates. Its job is to keep inflation and unemployment low. It does this in part by setting a short-term target interest rate based on the strength of the economy:
Although the Fed doesn’t control the rate you pay on your mortgage or credit card, the rate it sets influences those rates (and all other interest rates throughout the economy). The interest rate you pay on a given loan or financial product is also influenced by:
The interest rate you pay when borrowing money might be fixed or variable.
You might also notice that a single product has many different interest rates attached. For example, when you have a credit card, you might have one interest rate that applies to regular purchases, another if you miss a payment, and yet another if you’re withdrawing money from an ATM.
Your interest rate determines how much you’ll end up paying for something. Let’s say you took out a $200,000 mortgage that you’ll pay back over thirty years. Here’s how the total interest you’ll pay stacks up at different interest rates:
|At a rate of:||You pay total interest of:|
Even a small increase in your interest rate can make a big difference in what you pay over time.
Generally, the best interest rates go to creditworthy borrowers who don’t present much risk to the lender. You can show your worth by:
An interest rate is what you’re charged, expressed as a percentage, to borrow money. When you’re borrowing, a higher rate means you’ll pay more over the life of your loan. When you lend money, a higher interest rate means you’ll earn more. What interest rate you pay on a particular loan can be driven by a range of factors—from your credit score and the type of loan to Federal Reserve policy and the strength of the economy.