Interest Rates

A single number set by a handful of central bank officials ripples out to affect mortgage payments, credit card bills, and stock prices for an entire country almost simultaneously.

Cheat Sheet

An interest rate is the cost of borrowing money, or the reward for lending it, typically expressed as a percentage of the amount borrowed or saved over a set period.
Central banks, such as the U.S. Federal Reserve, set a benchmark interest rate that influences borrowing costs throughout the broader economy, from mortgages to credit cards to business loans.
Central banks generally raise interest rates to help cool down inflation by making borrowing more expensive and saving more attractive, and lower rates to stimulate a slowing economy.
Higher interest rates tend to reduce consumer spending and business investment, since loans become more expensive, while lower interest rates tend to encourage both.
Compound interest, in which interest is calculated on both the original amount and previously accumulated interest, can cause savings or debt to grow significantly faster over time than simple interest.
Interest rate changes affect nearly every part of the economy, including stock markets, housing prices, currency values, and the interest earned on everyday savings accounts.

The 60-Second Version

An interest rate is the cost of borrowing money, or the reward for lending it, typically expressed as a percentage of the amount borrowed or saved over a set period. Central banks, such as the U.S. Federal Reserve, set a benchmark interest rate that influences borrowing costs throughout the broader economy, from mortgages to credit cards to business loans. Central banks generally raise interest rates to help cool down inflation by making borrowing more expensive and saving more attractive, and lower rates to stimulate a slowing economy. Higher interest rates tend to reduce consumer spending and business investment, since loans become more expensive, while lower interest rates tend to encourage both. Compound interest, in which interest is calculated on both the original amount and previously accumulated interest, can cause savings or debt to grow significantly faster over time than simple interest. Interest rate changes affect nearly every part of the economy, including stock markets, housing prices, currency values, and the interest earned on everyday savings accounts.

The Long Version

The Cost of Money

An interest rate is fundamentally the cost of borrowing money, or conversely the reward for lending or saving it, typically expressed as a percentage of the amount borrowed or saved over a set period, usually a year. This simple concept underlies an enormous range of everyday financial products, from mortgages and car loans to credit cards and savings accounts.

Central Banks Set the Tone

Central banks, such as the U.S. Federal Reserve, set a benchmark interest rate that influences borrowing costs throughout the broader economy, from mortgages to credit cards to business loans, since banks and lenders generally adjust their own rates in response to changes in this benchmark. Central banks generally raise interest rates to help cool down inflation by making borrowing more expensive and saving comparatively more attractive, and lower rates to stimulate a slowing economy by making borrowing cheaper and spending more appealing.

How Rate Changes Ripple Through the Economy

Higher interest rates tend to reduce consumer spending and business investment, since loans become more expensive to take out and repay, while lower interest rates tend to encourage both by making credit more accessible and affordable. This is precisely why central bank interest rate decisions receive such intense, close attention from businesses, investors, and everyday consumers alike, since one number genuinely shapes financial decisions across the entire economy.

Compound Interest and Its Wide-Reaching Effects

Compound interest, in which interest is calculated on both the original principal amount and previously accumulated interest, can cause savings or debt to grow significantly faster over time than simple interest, which only ever calculates interest on the original amount. This compounding effect matters enormously for both long-term savers, who benefit from it, and long-term borrowers, who can see debt balances grow surprisingly quickly if left unpaid. More broadly, interest rate changes affect nearly every corner of the economy, including stock markets, housing prices, currency exchange values, and even the modest interest earned on everyday savings accounts.

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Glossary

Central bank: A national institution, such as the U.S. Federal Reserve, responsible for setting benchmark interest rates and managing a country's money supply.
Benchmark interest rate: The key interest rate set by a central bank that influences borrowing costs throughout the broader economy.
Compound interest: Interest calculated on both the original principal amount and previously accumulated interest, causing growth to accelerate over time.
Simple interest: Interest calculated only on the original principal amount, without factoring in previously accumulated interest.
Monetary policy: The actions a central bank takes, particularly adjusting interest rates, to manage inflation and overall economic activity.