An interest rate is a percentage that will be charged, per interest period, on a principal amount that a lender lent to a borrower.
What is an interest rate?
- An interest rate is a percentage of a loaned amount that is added to the total money owed to a lender per interest period.
- Interest rates can increase the payout of investments where investors loan out money.
- Interest rates can also hurt investors that borrow money to invest.
Interest rates are typically charged on a compounded basis. The longer a borrower owes money to a lender, the more interest they will have to pay back in addition to their borrowed principal amount.
Interest rates can be both positive and negative for investors. For investment opportunities such as bonds, money markets, CDs, or even simple savings accounts, investors will prefer higher interest rates. This is because investors are lending their money to another entity that will pay back the principal amount loaned with interest. The higher the interest rate in this scenario, the more money investors will be paid back.
Interest rates can also harm investors. If an investor chooses to borrow money, higher interest rates will increase the total owed money over time. Rising interest rates also hurt investors who purchase bonds. Because bonds have an inverse relationship with interest rates, the higher interest rates are, the lower the price of older bonds will become.
Interest rates are determined by macroeconomic changes, such as significantly changing the U.S. federal funds rate. This rate is used as the building block for the majority of interest rates in the U.S. economy.