What Drives Interest Rates?
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Interest rates are determined by the Reserve Bank and affected by the supply and demand present within an economy. In a booming economy, interest rates are typically high and in a sluggish economy, interest rates are typically low. Interest rates refer to the charge by the lender to a borrower, typically expressed as a percentage. Interest rates are expressed in two primary ways; nominal and real. Nominal interest rates are what most consumers are referring to when they speak about interest rate charges and they do not take into account for inflation. Real interest rates are interest rates where inflation has been taken into account.
Why are Interest Rates Important?
Consumers can come into contact with interest rates when applying for personal loans, automobile loans, credit cards or mortgages. Consumers are generally seeking the lowest interest rate offers when they are in need of personal or business financing. The lower the interest rate paid by a borrower will equate to a lower amount of money required to repay a loan. And, a lower interest rate can also mean a lower monthly required payment for a borrower.
Investors encounter the concept of interest rates when they invest into fixed investments such as bonds or CDs. Investors are seeking the highest interest rate offers when choosing investments as they will improve their portfolio's return and current income offered. Simply put, an investment interest rate offered directly correlates to an investor's return on investment.
Interest rates particularly affect the bond investment market. Bond prices typically work in an inverse fashion to interest rates. When interest rates rise, bond prices fall. And, when interest rates fall, bond prices rise.
Interest Rates and the Economy
One of the primary areas that interest rates affect is the general state of the economy. When interest rates are rising, inflation is often lower but the economy may be slowing down. Rising interest rates can also signal that the Consumer Price Index is rising which points to a slowing economy and is seen as a negative economic indicator. Banks and other traditional financial institutions often experience a slowing of lending during periods of rising interest rates which can negatively affect business expansion and the property market.
The Fed will often lower interest rates when the economy may need a boost. When the Fed meets to lower interest rates, it may take between 12-18 months for the economy to feel the full effects of this decision. Lower interest rates can also often mean higher inflation which can negatively impact the consumer. Overall, consumers and investors observe interest rate changes as a signal of the economy's overall state of health.
Comparing Interest Rates
The first thing to ensure when comparing interest rates is to make sure that you are comparing apples to apples; APR to APR or APY to APY. If you are comparing apples to apples, you may be attracted to an offer that only seems to offer lower interest rates rather than one that actually does. In addition to comparing interest rates, be sure to compare any additional fees, any balance transfer opportunities, any optional features and benefits to consider and rewards if you are comparing credit card offers. Remember; not all interest rates are created equal. So, when you are shopping and comparing rates, make sure that you are getting the best financial deal for your needs.