Interest rates are a vital factor in borrowing and saving decisions. They determine how much you pay (or earn) for the use of someone else’s money, whether it’s cash borrowed by a bank or credit union, or a savings account with ANZ.
High street banks set their interest rates based on many factors, including how much risk they take when lending or depositing your money. For example, a mortgage loan is secured by the borrower’s property, so it typically has lower risk than personal loans or credit card debt, which are not backed by collateral. A lender’s overall risk profile, the duration of the loan and whether it is a fixed or variable rate also affects interest rates.
Understanding the different types of interest rates and how they are calculated can help you make better financial decisions. For example, a simple interest rate is calculated by dividing the total amount owed or earned by the principal amount lent or invested over a period of time that’s normally one year.
Alternatively, compound interest takes into consideration the accumulated interest from previous periods, which can result in significantly higher totals than simple interest. For this reason, it’s more commonly used for saving vehicles like a bank or credit union’s online saver.
In terms of the economy, low interest rates are good for businesses and consumers as they encourage spending and riskier investments. However, this can lead to market disequilibrium where demand exceeds supply and inflation occurs.