Interest rates and how they work

An interest rate is the percentage of principal charged by the lender for the use of its money. The principal is the amount of money loaned.

Interest rates affect the cost of loans. As a result, they can speed up or slow down the economy. The Federal Reserve manages interest rates to achieve ideal economic growth.

You borrow money from banks when you take out a home mortgage. Other loans can be used for buying a car, an appliance, or paying for education.

Banks borrow money from you in the form of deposits, and interest is what they pay you for the use of the money deposited. hey use the money from deposits to fund loans.

Banks charge borrowers a slightly higher interest rate than they pay depositors. The difference is their profit. Since banks compete with each other for both depositors and borrowers, interest rates remain within a narrow range of each other.

The bank applies the interest rate to the total unpaid portion of your loan or credit card balance, and you must pay at least the interest in each compounding period. If not, your outstanding debt will increase even though you are making payments. Although interest rates are very competitive, they aren't the same. A bank will charge higher interest rates if it thinks there's a lower chance the debt will get repaid. For that reason, banks will tend to assign a higher interest rate to revolving loans such as credit cards, as these types of loans are more expensive to manage. Banks also charge higher rates to people they consider risky; The higher your credit score, the lower the interest rate you will have to pay.

Banks charge fixed rates or variable rates. Fixed rates remain the same throughout the life of the loan.  Initially, your payments consist mostly of interest payments. As time goes on, you pay a higher and higher percentage of the debt principal. Most conventional mortgages are fixed-rate loans.

Variable rates change with the prime rate. When the rate rises, so will the payment on your loan. With these loans, you must pay attention to the prime rate, which. is based on the fed funds rate. With either type of loan, you can generally make an extra payment at any time toward the principal, helping you to pay the debt off sooner.

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