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Interest rates 101

Interest rates 101

December 11, 2013

No matter where you live or what you buy, it’s hard to escape the influence of interest rates. They can increase your home’s value, wreak havoc on a company’s value and reduce the amount of time it takes to pay down a loan. Regardless, understanding how interest rates work and how to work them to your advantage, can have a significant influence on your financial health.

So what exactly is an interest rate? 

It’s the cost of borrowing
An interest rate is the amount of money charged, as a percentage, by a lender to a borrower for the use of an asset such as a car, a house or a business. The formula for figuring out simple interest is easy enough: If you were to borrow $1,000 at a 6% annual interest rate for 6 months, you would owe $30. 

The trick, however, is making sure that interest rates work in your favour. Consider, for example, credit card payments. When you borrow money, you generally have to pay interest. A credit card is no exception. A credit card issuer charges the cardholder interest for the period of time in which the money remains borrowed. 
You can minimize the costAlthough a credit cardholder doesn’t have any direct influence on a card’s interest rate, he or she can take steps to minimize interest charges. Strategies include:
  • Paying off your credit card balance in full each month.
  • Selecting a credit card with the lowest rate available.
  • Consolidating debt from higher interest cards to a lower interest credit card.
  • Making payments in a timely fashion. 

Sometimes, though, the higher the interest rate, the better. Take, for example, your savings. Each time you deposit money into a bank account, the bank will pay you interest on your savings. Again, investors have little say in interest rate percentages. 

Maximize the earnings

But there are ways to maximize the amount of interest earned on your savings. These include:

  • Researching a variety of savings vehicles and selecting one with the highest interest  rate.
  • If the savings account requires you to maintain a certain balance in order to earn interest,  make sure you stay above that amount.
  • Leave your money in the account for as long as possible. 

Interest rates may rise and fall but the better understanding you have of these ubiquitous percentages, the more money you’ll earn and save.