Interest rates affect everything from mortgages and credit card debt to the growth of retirement savings and even the price of new cars. But what exactly are they and how do they work?
The simple answer is that interest is a fee charged by lenders for the use of their funds. It’s a way to compensate them for the loss of opportunity cost – the money they could have invested instead of lending it out. It also helps to offset the risk of default. This is especially true for longer-term loans and debts, which carry a greater risk of default because the lender is tied up in the asset for a longer period of time.
Lower rates make it cheaper for consumers and businesses to borrow money, which typically stimulates spending. However, when rates rise it can make borrowing more expensive and may slow down economic growth to control inflation.
In terms of investing, companies that benefit from higher rates include those in the financial sector such as banks, credit unions, insurance companies and investment firms. Their profit margins expand as rates climb and they can pass on these benefits to their customers.
Savings vehicles like savings accounts and GICs also benefit from higher rates. As a result, many senior citizens are better off during a rate boost because they will be earning more on their retirement savings.
About the Author
