Interest rates play a critical role in how much debt costs and how much you can earn on savings. They are part of the formula for calculating mortgages, car loans and credit card debt. Understanding how these rates are calculated may help you make wiser financial decisions and maximize the return on your investments.
What is an Interest Rate?
An interest rate is a cost of borrowing money or the rate of return on depositing it. It is typically shown as a percentage and charged or earned on a regular basis. The calculation of an interest rate depends on the structure of a loan or investment. It may be simple interest, compound interest or accrued interest. Different terms are used to describe an interest rate, including the annual percentage yield (APY) offered on savings accounts and the Bank Rate in the United States.
Whether you are looking for the best mortgage or considering investing in stocks, understanding interest rates can help you understand what you are getting into. The prevailing interest rate is determined by a number of factors, such as the economy and monetary policy set by central banks.
When making long-term financial decisions, it is also important to consider inflation trends. For example, the nominal interest rate that is often advertised for savings accounts or loans ignores inflation, whereas real interest rates take it into account to reflect the buying power of the principal over time. Using a calculator to compare nominal and real interest rates can help you better evaluate returns or cost when planning for the future.
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