Why Interest Rates Matter & What You Need to Know as a Consumer (2024)

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An interest rate is a percentage rate used in the world of loans and represents the cost of borrowing money. For lending you money, lenders will charge a percentage of the principal amount they loaned to you.

Let’s say you took out a loan of $1,000. If the interest rate was 10% per year, you would owe the $1,000 you took out as a loan and you would owe $100 in interest. So, if no payments were made for the year, you would owe a total of $1,100 at the end of one year.

Interest rates can vary from high to low depending on many factors:

Loan type
Credit score
Location
Loan amount
Loan term
Down payment
Interest rate type

WHY DO INTEREST RATES MATTER?

Why Interest Rates Matter & What You Need to Know as a Consumer (1)

Interest rates matter because they determine the cost of borrowing.

Knowing the cost of borrowing is important for a consumer to know because consumers borrow for many large purchases throughout their lives for things including education, cars, and homes.

Higher interest rates on a loan lead to higher amounts of interest owed for a given period of time.

By knowing what an interest rate is, you can use the rate to make smarter financial decisions when borrowing or lending. You’ll know what an appropriate rate looks like and identify an attractive or unattractive rate.

Interest rates can be charged for any transaction that requires the borrowing of money. This includes you receiving a loan or lending money out to someone else, like a bank for example.

EXAMPLES OF WHERE INTEREST RATES ARE INVOLVED

Personal loans

Funds used for personal use
Interest rate range: 7% to 36%

Home loans

Funds used to purchase a home
Interest rate range: 2% to 7%
Term of loan, along with other factors, impact the rate

Student loans

Funds used to pay for tuition and education expenses
Interest rate range for federal loans: 5% to 7%
Interest rate range for private loans: 3% to 14%

Car loans

Funds used to purchase a car
Interest rate range: 3% to 10%

Credit cards

A type of personal loan where funds are used for anything you are able to charge to a credit card
Interest rate range: 12% to 20%
Some cards offer 0% interest rates for the first 12-18 months

Loans for consumer goods

Funds typically used for large purchases on consumer goods, such as appliances for your home
Interest rate range: 5% to 10%

Savings accounts

When you lend the bank money in the form of a savings account, they pay you interest for you letting them hold your money
Interest rate range: 1% to 3%

As you see above, interest rates can be highly variable. It is important to note that the interest rate ranges above vary based on several factors mentioned in the intro including:

Loan type
Credit score
Location
Loan amount
Loan term
Down payment
Interest rate type

HOW TO GET THE LOWEST INTEREST RATES

Why Interest Rates Matter & What You Need to Know as a Consumer (2)

When taking out a loan, a big focus of yours will be to find the lowest interest rate possible (but not at the expense of the other factors).

Given that the other aspects of the loan are attractive, focusing on receiving the lowest interest rate is important because the lower the rate, the lower the cost of borrowing.

Imagine you take out a loan for $100,000.

If your interest rate is 10%, you will pay $10,000 in interest.

If you can get that same loan amount at a 5% interest rate, you will only pay $5,000 in interest and will save $5,000.

On top of that $5,000 in savings, your monthly payment on your loan will be a lot lower as well, further decreasing the financial burden that borrowing money can cause.

Here are ways to put yourself in the best position to receive low interest rates:

Increase your credit score
Get quotes on rates from multiple lenders and negotiate a lower rate
Use a larger down payment from the beginning (ex: car and home loans)
Build a record of employment
Use a co-signer
Sign up for autopay if a discount is offered
Opt for a shorter payment period
Survey interest rate options (Ex: fixed, variable, etc)

JUST AS IMPORTANT AS THE INTEREST RATE

The interest rate on its own is not the only thing that matters. The context of the rate is just as important.

You need to look at what an interest rate is being applied to and how it is being applied.

Many times, interest rates on offers look attractive from the start but can end up leading to a financial catastrophe if you do not fully read the terms of a loan.

THINGS YOU SHOULD LOOK AT WHEN BORROWING AND QUESTIONS TO ASK

Interest rate

EXAMPLES OF THE DIFFERENT TYPES OF INTEREST RATES

Annual Percentage Rate (APR)

The annual percentage rate charged by a lender for borrowing money

Fixed

A fixed-rate means the interest rate will remain the same over the term of a loan. If your beginning rate is 5%, you will pay 5% interest for the entirety of the loan.
Its benefit is always knowing what amount you’ll pay each month.
Another benefit comes from taking advantage of a low-interest rate environment. If underlying benchmark interest rates are low (ex: LIBOR or federal funds rate), you can lock in a low fixed interest rate. Then when interest rates rise, your rate will remain the low fixed amount.

Variable

A variable interest rate fluctuates throughout the term of a loan based on the movement of interest rates on an underlying benchmark rate such as the LIBOR or federal funds rate.
The benefit of a variable rate is that your rate could decrease from the original rate amount you signed for. If you took out the loan and the rate was at 6%, it is possible your rate could decrease to 4%.
This variability is also a downside as well. If you signed up for an interest rate at 6%, that rate could creep up to 8%.
With variable rates, your loan payment due each month can vary.

Prime rate

Prime rates are interest rates given to preferred customers or those with the highest creditworthiness.
If you have a high credit rating and pay your bills on time, you can be rewarded with lower rates since your are seen as a trustworthy borrower in the eyes of a lender.

Nominal

A nominal interest rate is the interest rate before taking inflation into account

Real

A real interest rate is the interest rate after taking inflation into account.
Real interest rate = nominal interest rate – inflation
If you take out a loan for $5,000 and the interest rate is 5% and inflation is 3%, the real interest rate you are paying is 2%.

PROTECTING YOURSELF FINANCIALLY

Why Interest Rates Matter & What You Need to Know as a Consumer (3)

Understanding interest rates, the context of interest rates, and the corresponding math behind them will allow you to protect yourself financially and make informed decisions when borrowing or lending to others.

Too often, consumers are lured in by the attractive interest rates they see in advertisem*nts. If an interest rate seems too good to be true, it probably is. There is always a catch and you need to thoroughly read the terms and details of any interest rate or loan you encounter.

As for lending, you’ll always want to lend your money out at an attractive interest rate. Whether it is a savings account, money market account, or a purchase of a bond, you will want to put your money somewhere to earn a high amount of interest for an associated level of risk.

About Post Author

Brandon Hill

I’m Brandon Hill with Bizness Professionals. We serve content to help young professionals develop personally, professionally, and financially. Well-rounded improvement is a theme we live by. As such, this website will cover a variety of topics aimed to help you have a successful life and career.

See author's posts

Brandon Hill

I'm Brandon Hill with Bizness Professionals. We serve content to help young professionals develop personally, professionally, and financially. Well-rounded improvement is a theme we live by. As such, this website will cover a variety of topics aimed to help you have a successful life and career.

FAQs

Why Interest Rates Matter & What You Need to Know as a Consumer? ›

Interest rates influence borrowing costs and spending decisions of households and businesses. Lower interest rates, for example, often encourage more people to obtain a mortgage for a home or to borrow money for an automobile or home improvements.

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Why do interest rates matter to consumers? ›

When interest rates are high, it's more expensive to borrow money; when interest rates are low, it's less expensive to borrow money. Before you agree to a loan or sign up for a new credit card, it's important to make sure you completely understand how the interest rate will affect the total amount you owe.

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What is an interest rate and why does it matter? ›

An interest rate tells you how high the cost of borrowing is, or high the rewards are for saving. So, if you're a borrower, the interest rate is the amount you are charged for borrowing money, shown as a percentage of the total amount of the loan.

How can interest rates affect consumers? ›

Interest rates affect spending in a number of ways. Higher interest rates mean higher payments on many mortgages and loans. So people with those things need to spend more on them and have less to spend on other things. Higher interest rates also mean savers get more return on their savings.

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How do interest rates affect people? ›

Higher interest rates can make borrowing money more expensive for consumers and businesses, while also potentially making it harder to get approved for loans. On the positive side, higher interest rates can benefit savers as banks increase yields to attract more deposits.

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Who benefits from high interest rates? ›

With profit margins that actually expand as rates climb, entities like banks, insurance companies, brokerage firms, and money managers generally benefit from higher interest rates. Central bank monetary policies and the Fed's reserver ratio requirements also impact banking sector performance.

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What are the three main factors that affect interest rates? ›

Interest rates are affected by many outside forces too including supply and demand, economic policies, and inflation.

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Why raise interest rates when inflation is high? ›

In a context of rising inflation, central banks can decide to increase the interest rates which will discourage consumers from spending, as borrowing money is more expensive.

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How do high interest rates affect individuals? ›

Because borrowing becomes more expensive, people and businesses tend to spend less. This decreased spending may mean companies hire less or have layoffs, see lower productivity and face reduced earnings. These effects often cause stock prices to fall.

How do negative interest rates affect consumers? ›

Indeed, negative interest rates also give consumers and businesses an incentive to spend or invest money rather than leave it in their bank accounts, where the value would be eroded by inflation.

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How do people behave when interest rates are high? ›

High interest rates make goods and services more expensive due to the increased cost of borrowing through higher rates. This keeps people from spending their money, which means they are saving it. Additionally, if rates are high, consumers can receive higher returns on their savings, which further encourages saving.

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Who suffers when interest rates rise? ›

Rate hikes make it more expensive to borrow, discouraging consumers from making large purchases and companies from hiring and investing.

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What impact does interest have on individuals? ›

Interest rates affect the decisions you make with money. Some of these are obvious – think about how much more money you would stick in your savings account if it paid 15% interest instead of 0.5%. How much less money would you put into stocks or your 401(k) if you could get 15% in a simple bank account?

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Why does APR matter to the consumer? ›

Your APR matters if you don't pay your balance in full every month. If you carry a credit card balance, your card's APR is critical. When you don't pay off your statement balance in full, your lender charges you interest on any remaining balance.

What are the disadvantages of low interest rates on consumers? ›

It prompts consumers to postpone purchases due to a view that things will soon cost less. Businesses respond to falling demand by cutting prices, which reduces their profits and investment. Unemployment climbs. As prices fall, real debt burdens climb.

Why do interest rates matter to investors? ›

In many circ*mstances, interest rate movements can affect stock prices. The biggest impact stock prices have on interest rates is on the demand for bonds. If stock prices decline, it may indicate investors are seeking to reduce portfolio risk and putting more money to work in bonds.

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Why are high interest rates good for the economy? ›

Because higher interest rates mean higher borrowing costs, people will eventually start spending less. The demand for goods and services will then drop, which will cause inflation to fall.