Interest Rate
Definition
The percentage charged by a lender on borrowed money or paid to a saver on deposited funds, expressed as an annual percentage.
An interest rate is the cost of borrowing money or the reward for saving it, expressed as a percentage of the principal amount per year. Interest rates are set by market forces, central bank policies, and individual lender decisions based on risk assessment.
The Federal Reserve influences short-term interest rates through the federal funds rate, which cascades through the financial system to affect mortgage rates, savings rates, credit card rates, and business lending rates. When the Fed raises rates, borrowing becomes more expensive but savings earn more.
Interest rates can be fixed or variable, simple or compound, and nominal or real (adjusted for inflation). Understanding the type of interest rate on your financial products is essential for making informed decisions about borrowing, saving, and investing.
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Related Terms
APR (Annual Percentage Rate)
financeThe yearly cost of borrowing money expressed as a percentage, including fees and interest charges.
APY (Annual Percentage Yield)
financeThe effective annual rate of return on an investment or savings account, accounting for compound interest.
Prime Rate
financeThe interest rate that commercial banks charge their most creditworthy customers, serving as a benchmark for many consumer and business loan rates.
Compound Interest
financeInterest calculated on both the initial principal and the accumulated interest from previous periods, causing wealth to grow exponentially over time.
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