Interest Rates

How Interest Rates Affect You and the Economy

What is an interest rate?

The amount of a loan payment is measured by three things: how much the principal (original) amount of money is, the interest rate, and the term (length) of the loan.

The interest rate is the interest (amount of money) that a loan gains annually. A lender uses an interest rate, rather than just getting the original money back, to get a profit off the loaned money. For example, if Jim borrowed $200 from Spock, and Spock loaned it at a 10 percent interest rate annually, then 2 years later Jim would have to pay $242. Why? because for the first year of having the loan, he would owe 10% more ($220). Then, the next year it would be 10% more ($242).

How would my interest rate be determined?

An interest rate is usually determined by the credit rating of the borrower, the prime rate, and type of loan. The prime rate is what the lender's lowest interest rate would be. After seeing your credit rating, the lender may make your interest rate lower, or higher. If your credit rating is high, the lender will lower your interest rate because they know you will pay it all back. But, if you have a low credit rating, the lender will raise the interest rate because they wouldn't know for sure that you would pay it all back to them.

How does the interest rate effect the economy?

Interest rates are controlled in part by the government, which sets the prime rate. If you control the interest rates, you can control the economy. How? Because the interest rates affects the amount of work a person has to do. If you change he interest rates, the country could either grow stronger (if you raise it just enough), or it could fall (if you raise it too high). If you lower the interest rates, the amount of work a person has to do will decrease. You would do this if the people had too much work to do or if the country was getting weaker.