Consumers can define an interest rate as the cost of borrowing money, on the other side, it is the compensation for the service and risk of lending money. People would not be willing to lend or store their cash without it since it refers to a set of conditions that affect both parties.
Interest rates are dynamic and there are different types of loans that offer various interest rates. If you are either a lender, a borrower or took on both roles, it is important to have knowledge about the reasons for the changes and differences that occur.
Read about How Interest Rates Affect Human Spending Habits.
Incomes consider interest rates as a major factor, one can earn by lending money but it is important to understand how and why prevailing interest rates change.
Two Sides of the Coin
In this case, being a lender means you take on the risk of having the loan ending up unpaid, thus a compensation for that risk would be what the interest can provide.
A borrower is the one who pays interest because they have gained the luxury of being able to spend now, rather than having to save up for years and wait. Examples can be taken out of taking out a mortgage or getting a loan for a car.
Determine the Interest Rates
Supply and Demand
Supply and Demand of credit covers interest rate levels as a factor. This means that an increase in the demand for credit triggers a raise in interest rates while decrease in the demand for credit causes a decline in them. The same law follows with the supply aspect.
As an increase in the money made available to borrowers happens, so does the supply of credit while credit available to the economy is decreased as the deferring of repayment is decided by lenders about their loans.
An increasing inflation can put an overall economy in a disadvantage, as profit margins are narrowed and the job market embodies lay-offs. Interest rates are likely to raise as inflation rates gets higher. This happens because as a compensation for the decrease in purchasing ability, lenders will demand higher interest rates.
The government usually has a role on how interest rates are affected. The U.S. Federal reserve has the ability to raise the fed funds target rate to temporarily compromise with the economic growth, which can serve to lower inflation throughout time. They also often make announcements about the monetary policy’s effect on the interest rates. A rise in these said funds rate negatively affects the ability of consumers and all businesses alike to obtain credit at a low rate.
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