Interest

Interest is the cost of borrowing money, paid by the borrower to the lender, typically expressed as an annual percentage of the loan amount. When you borrow money through a mortgage, car loan, or credit card, you pay interest. When you deposit money in a savings account or buy a bond, you earn interest. Interest rates are determined by supply and demand for money, inflation expectations, central bank policies, and the creditworthiness of borrowers. The Federal Reserve and other central banks set benchmark interest rates that influence rates throughout the economy. When central banks raise rates, borrowing becomes more expensive, which can slow economic activity and reduce inflation. There are two main types of interest: simple and compound. Simple interest is calculated only on the original principal. Compound interest is calculated on the principal plus any accumulated interest, causing the amount to grow faster over time. Albert Einstein allegedly called compound interest the "eighth wonder of the world" because of its powerful effect on long-term wealth building. For borrowers, understanding interest is crucial for making smart financial decisions. A difference of even one percentage point on a mortgage can mean tens of thousands of dollars over the life of the loan. Credit card interest rates are particularly high, often exceeding 20%, making it important to pay off balances quickly. For investors, interest rates significantly affect asset values. When rates rise, bond prices fall, and vice versa. Stocks can also be affected because higher rates increase the cost of corporate borrowing and make bonds relatively more attractive compared to stocks. The relationship between interest rates and the economy is complex. Low rates encourage borrowing and spending, potentially boosting economic growth but also risking inflation. High rates have the opposite effect. Central banks constantly balance these considerations when setting monetary policy.