Ever wonder why your savings account grows (even if just a little) or why borrowing money comes at a cost? It all boils down to one powerful concept: interest rates. It’s a subtle financial principle which dictates numerous different things throughout the world of economics. These include, but are not limited to shaping how much you pay on a loan, to how much money you make by owning a savings account. Every penny you spend and save is affected by interest rates, so having a strong understanding of them can help bolster your financial wellness throughout your life.

To grasp a basic understanding of interest rates, we need to first examine what they actually are. Think of interest rates like the “price tags on money.” When you take out a loan, use a credit card, or borrow money from an entity, interest rates are the penalty that you have to pay in exchange for their services. Likewise, interest rates are also the reward you get for lending your money to banks and other financial institutions. When rates go up, your net worth could go up or down depending on your ratio of liquid assets in places that can earn you interest to your amount of liabilities that extract interest from your pockets. So, to stay ahead of the game, it is good to know how and why interest rates fluctuate and how to calculate these fluctuations.

Interest rates fluctuate at the hands of a multitude of factors. These include: 

Central Bank Policies-Banks at the federal level, such as the federal reserve, adjust interest rates to maintain a healthy economy and combat inflation that arises from a rapidly growing economy, and deflation of wealth that is caused by a slow growing economy. Lower interest rates encourage more spending, and higher interest rates encourage less spending due to interest rates having a huge impact on the everyday goods and services we purchase.

Loan Supply and Demand-If more people want to take out loans, interest rates may rise to help banks make more money off of these loans, which causes demand for loans to go down and interest rates to follow suit.

Global Economics-The status of foreign economies can affect domestic interest rates by stimulating/discouraging economic activity depending on the stability of foreign banks.

To approximate how much you will make via interest, you must evaluate which type of interest you are earning. There are two primary types of interest which are:

-Simple Interest: Interest that is continuously applied to your starting deposit of money and does not build over time. To calculate simple interest, multiply your starting value by your rate, and then take that value and multiply it by your total time.

-Compound Interest: Compound interest is just like simple interest, except you take your amount earned and continuously multiply it by your rate. To calculate your money made off of compound interest, multiply your initial deposit by your rate in percent divided by the number of times the interest is compounded. Then raise that to the number of times interest is compounded per year times your number of years.
All in all, it is clear that interest rates are an essential part of your financial life. Thankfully, with this knowledge and the vast amount of resources available, you will be able to better your understanding of interest rates to effectively get ahead.