If you pay attention to news on a regular basis, you will notice that interest rates are involved in nearly everyone's financial life. From Federal Reserve Chairperson Janet Yellen raising the federal funds rate to mortgage interest rates diving, the world revolves around interest rates. By learning about interest rates, you can understand the world of finance and how it affects the average person.
Many people from all walks of life are both terrified of and confused by interest rates. Interest rates may seem like some arcane aspect of economics or finance, but they are quite simple if you take some time to learn their purpose in society.
What are Interest Rates
An interest rate is the cost of borrowing money. It may be useful to think of an interest rate as the price you pay for using a credit card or taking out a loan. Interest rates also represent people's time preferences. In general, people prefer to have more money now than in the future. This means that people who lend their money will demand an interest rate to cover the inconvenience of parting with some of their cash.
However, value is subjective; some people value the present highly while others have a weaker preference for the present. If lenders can freely negotiate their rates with borrowers, people with a strong preference for the present will demand high interest rates. Likewise, people with a weak preference for the present may accept lower interest rates.
Interest rates are applied to all kinds of credit. Credit cards, auto loans, mortgage loans, and payday loans are some of the many formal varieties of credit, but interest rates could be used when you informally borrow money from a relative. Interest rates simply ensure that the lender benefits from providing funds to a borrower.
Interest Rates on Mortgage Loans
If you are looking at homes for sale in Central Texas, you are probably interested in mortgage loans. The basic explanation of interest rates also applies to mortgage rates, but you should also be aware that there are two kinds of rates for mortgages.
The first kind of mortgage interest rate is the fixed rate. As its name suggests, the fixed rate does not change over the years. This kind of mortgage rate behaves like a traditional interest rate. However, some mortgage loans come with adjustable rates. Also known as variable rates, these adjustable mortgage interest rates change with certain economic conditions. For example, a higher inflation rate often causes the adjustable rate to increase.
By now, you should realize that interest rates are not difficult to understand. They are simply prices used by borrowers and lenders.