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Word of the Week: Interest rates
Welcome to Mouth Money’s Word of the Week, a weekly dive into essential personal financial phrases and words. We want to help simplify complex financial jargon and empower your understanding of money. This week: interest rates
An interest rate is the cost of borrowing money or the return on investment for lending to others. It plays a crucial role in the financial system, informing the cost or reward of products such as loans, savings accounts, mortgages, and investments.
Here’s a breakdown of how interest rates work in personal finance:
- Economic indicators:
- The Bank of England’s Monetary Policy Committee (MPC) sets the base interest rate for the UK economy. Changes in this rate have a ripple effect on other interest rates. For example, when the base rate is lowered, banks tend to lower their lending and savings rates, making borrowing cheaper but reducing returns on savings and vice versa.
- Borrowing money:
- Loans: When you borrow money, such as through a personal loan or a credit card, the interest rate is the percentage that the lender charges you on top of the principal amount borrowed. This is the cost of borrowing money, and it’s typically expressed as an annual percentage rate (APR). The APR includes not only the interest but also any additional fees associated with the loan.
- Mortgages: When you take out a mortgage to buy a home, the interest rate determines how much you’ll pay over the life of the loan deal. Mortgage interest rates can be fixed for a certain amount of time (usually two, three or five years) or variable (changing periodically, usually in relation to the Bank of England’s base rate).
- Saving and investing:
- Savings accounts: When you deposit money in a savings account, the bank pays you interest on your savings. This interest is typically lower than the interest rates on loans because you’re essentially lending your money to the bank. Savings account interest rates can be variable or fixed.
- Investments: In the context of investments, interest rates can affect various financial products. For example, bond yields are influenced by prevailing interest rates. When interest rates rise, bond prices tend to fall and yields rise. Additionally, the return on savings and investment products such as Individual Savings Accounts (ISAs) is influenced by interest rates.
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