Interest Rates: The Cost of Borrowing and Return on Funds
Interest rates are usually expressed as a percentage of the principal. They can measure the cost of borrowing, as well as the return generated by savings or investments. Understanding how interest is calculated and the factors that affect it helps in comparing loans, savings, and investment options.
The Basic Meaning of Interest Rates
When borrowers use loans or credit cards, they typically need to repay the principal plus additional interest; the ratio of interest to principal is the interest rate. For providers of funds, the interest rate can also represent the level of return earned from lending funds, holding savings, or investing in bonds.
Simple Interest and Compound Interest
Simple interest calculates interest only on the initial principal and does not include interest that has already accrued in subsequent calculations. Compound interest calculates interest on both the principal and previously accumulated interest, creating an effect in which “interest also earns interest.” The longer the term, the more pronounced the difference between the results of the two methods may become.
Why Interest Rates Matter
Interest rates affect the total amount repaid on a loan, as well as the growth rate of savings and some investments. Higher interest rates generally mean higher borrowing costs, but they may also increase the interest returns on deposits or bonds. When assessing actual returns, the erosion of purchasing power caused by inflation should also be considered.
Factors Affecting Interest Rates
Central banks can influence the money supply, borrowing, and economic activity by adjusting short-term policy rates; changes in inflation may also prompt interest-rate adjustments. In addition, lenders assess a borrower's risk of default, and those with higher risk typically have to bear higher interest rates.
Original Tutorial
https://www.binance.com/zh-CN/academy/glossary/interest-rates
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