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Interest Rates

When you take out a mortgage or other type of loan, your lender will charge a percentage of the loan as a fee for borrowing its money. The interest rate adds to the total balance of your loan; typically, you must pay at least the interest on your loan each month. Prevailing interest rates affect how much you can afford to borrow: if interest rates are high, you may not be able to buy an expensive property. High interest rates also can cause the value of any property you own to stagnate or fall. Understanding prevailing interest rates can help you to assess loans more effectively.

Types of Interest Rates

The amount of interest that you pay as a borrower depends on whether the interest rate is variable or fixed.

  • Variable rates depend on the prime rate, which is the rate of interest that banks charge their preferred customers (and thus is the lowest available rate). Variable rates change when the prime rate shifts.
  • Fixed rates do not fluctuate but remain the same throughout the term of the loan.

How Interest Rates Are Determined

While the banking industry can change the prevailing rate for mortgages and other loans, interest rates for mortgages and other loans depend on forces other than the banking industry. For instance:

  • Short-term and variable interest rates are set by the Federal Reserve.
  • Long-term and fixed interest rates are determined by the demands of businesses and individuals who invest in U.S. Treasury bonds.
  • Interest rates for loans that are less likely to be repaid, such as credit card debt, depend in part on risk; banks charge higher interest rates for such relatively risky loans.

Last updated Nov. 20, 2018

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