Home > Personal Finance > How Interest Rates Affect Every Aspect of Your Personal Financial Life

Comments 0 Comments

If you’ve ever made a student loan payment or carried a credit card balance into a new month, you already know how interest rates work.

In those cases, it’s the percentage tacked onto your principal debt, or the price you pay later for borrowing money now.

These rates are intertwined with every aspect of our personal financial lives. Here’s your primer (or reminder) on how interest adds to all of life’s financial balances.

1. Understanding the Federal Funds Rate

The federal funds rate (FFR), the interest rate of all interest rates, is calculated by the Federal Reserve and determines how much a bank needs to pay if it borrows money from another bank. The FFR also determines the rate at which a bank lends to (or borrows from) you. When the FFR increases or decreases, the interest rates for the rest of the personal finance decisions on this list also shift.

When the FFR is low, banks can offer lower interest rates to consumers, so we’re all incentivized to borrow, which means we’re more likely to spend. When the FFR is high (and consequently, interest rates are high), we’re not.

2. Using a Credit Card

The APR, or annual percentage rate, is the rate at which your card issuer charges you interest every year. They might offer a range of 15% to 21%, for example.

Although the card’s APR is affected by rates like the FFR, it’s also determined by the issuer and your credit history. A stronger credit history qualifies you for lower APRs on credit cards, including rewards cards.

Part of the reason that credit card users can end up in debt quickly is that credit card interest is calculated daily. This means it costs you extra money every day you maintain a credit card balance.

Just to make things more complicated, the interest rate on your credit card is itself variable, meaning it could go up at a month’s notice. On the bright side, you could always ask your issuer for a lower rate—and if your credit is good, you could qualify for one.

3. Taking Out or Refinancing a Student (or Personal) Loan

If you pay off your loans early, you can save on interest. Increasing your payment by $50 per month when you have $35,000 in debt with a 5.7% interest rate, for example, would shave 16 months and $1,749 of interest off your loan. A student loan prepayment calculator can show you how much could be saved in any situation.

The interest rate of student loans is more complex than that of credit cards. As with credit cards, your creditworthiness affects the fixed or variable APR you might be offered when taking out a private student loan or personal loan. You could also score a better rate by doing any of the following:

  • Having a good debt-to-income ratio
  • Including a co-signer who has a strong credit report
  • Setting up auto-pay as part of your repayment plan

Lenders’ rate ranges are typically dependent on either the prime rate set by the Federal Reserve or the London interbank offered rate (Libor).

Federal student loans are different, however, and the interest rates of federal loans are determined by Congress. Between July 2017 and July 2018, for example, an undergraduate could take out a Direct Unsubsidized Loan with a 4.45% interest rate or resort to a private lender offering rates between 3% and 12.5%.

The advantage of federal loans is that rates are fixed across the board and that some of these loans are subsidized, meaning the government picks up the tab on interest while the borrower is in school. Upon graduation, however, some borrowers benefit from finding a lower interest rate on a refinanced loan.

4. Buying or Leasing a Car

Unless you have the cash, borrowing money helps you cover the gap between your down payment and the total cost of a car. Instead of figuring out your loan at the dealership, though, you may be better served by visiting your local bank or credit union first. This way, you can walk into a car dealership already having received a rate quote, which can give you more leverage in negotiation.

In addition, the dealership, like a credit card issuer or student loan company, considers your credit score when determining what interest rate it can offer. A car buyer with poor credit could see rates 11 percentage points higher than a more creditworthy peer, according to 2017 data from Experian. The interest rate on these sorts of subprime loans could reach upwards of 30%.

If that deters you from buying, be aware that leasing a car has its own set of rules for interest. Money factor is a term you’ll hear salespeople throw around. It’s an interest rate that helps determine your monthly payment on a leased vehicle. To see the equivalent in APR, multiply the money factor amount by 2,400.

5. Buying a Home

Buying a car is a big deal, sure, but buying a home is probably the biggest financial decision you’ll make in your lifetime. Because it also requires borrowing, it’s subject to the world of interest rates.

With fixed and variable mortgage rates, every percentage point matters. There’s a big difference between even a 4% and a 5% interest rate, as any home mortgage calculator can tell you. If you borrow $150,000 at 4%, for example, you’ll pay $160,205 in interest over a 30-year mortgage. Borrowing at 5% would instead cost you $192,284 in interest.

Here are some other things that could help you qualify for a lower interest rate:

  • Saving up a larger down payment
  • Having a shorter mortgage term
  • Sporting a superb credit score

With homebuying, it’s especially important to understand the difference between interest rates and APR. The latter includes the interest rate on your loan, plus other homebuying costs such as broker fees.

Both interest rates and APRs can be used to compare loan quotes, as long as you’re making apples-to-apples comparisons and comparing similar elements of each kind of loan.

6. Earning Bank or Stock Dividends

Whether you’re using a credit card to make a small purchase or a loan to make a bigger one, you’re borrowing money. But in the case of your savings and investments, you’re actually the lender. Banks pay interest in the form of annual percentage yield (or APY) for the right to hold (and shift) your money around.

These interest rates vary across account types. A legacy savings account, for example, might pay you as little as 0.01% for your money. A high-yield online savings account, meanwhile, could pay you as much as 1%. Compounding, which is accounted for in APY but not APR, occurs when your interest earns interest.

When the FFR is increased, it might be bad news for borrowers, but it’s good news for savers. As the FFR goes up, interest rates on savings vehicles like certificates of deposit, or CDs, will likely climb. And just as compound interest can increase your debt on a loan, it can increase your dividends on a bank account.

Keep Interest Rates in Mind for Every Big Decision

Interest rates are a part of the fabric of every personal finance decision in our lives. Just being more aware of interest rates in general can save you time when comparing bank offers. It could also save you thousands of dollars in debt—or even help your money grow faster. Whether you’re borrowing money for your education or perhaps saving up to finance your child’s, understanding how interest works is imperative. Before any big money decision, though, it’s a good idea to check your credit score. You can check your credit for free at Credit.com.

 

Image: istock

Comments on articles and responses to those comments are not provided or commissioned by a bank advertiser. Responses have not been reviewed, approved or otherwise endorsed by a bank advertiser. It is not a bank advertiser's responsibility to ensure all posts and/or questions are answered.

Please note that our comments are moderated, so it may take a little time before you see them on the page. Thanks for your patience.

Certain credit cards and other financial products mentioned in this and other sponsored content on Credit.com are Partners with Credit.com. Credit.com receives compensation if our users apply for and ultimately sign up for any financial products or cards offered.

Hello, Reader!

Thanks for checking out Credit.com. We hope you find the site and the journalism we produce useful. We wanted to take some time to tell you a bit about ourselves.

Our People

The Credit.com editorial team is staffed by a team of editors and reporters, each with many years of financial reporting experience. We’ve worked for places like the New York Times, American Banker, Frontline, TheStreet.com, Business Insider, ABC News, NBC News, CNBC and many others. We also employ a few freelancers and more than 50 contributors (these are typically subject matter experts from the worlds of finance, academia, politics, business and elsewhere).

Our Reporting

We take great pains to ensure that the articles, video and graphics you see on Credit.com are thoroughly reported and fact-checked. Each story is read by two separate editors, and we adhere to the highest editorial standards. We’re not perfect, however, and if you see something that you think is wrong, please email us at editorial team [at] credit [dot] com,

The Credit.com editorial team is committed to providing our readers and viewers with sound, well-reported and understandable information designed to inform and empower. We won’t tell you what to do. We will, however, do our best to explain the consequences of various actions, thereby arming you with the information you need to make decisions that are in your best interests. We also write about things relating to money and finance we think are interesting and want to share.

In addition to appearing on Credit.com, our articles are syndicated to dozens of other news sites. We have more than 100 partners, including MSN, ABC News, CBS News, Yahoo, Marketwatch, Scripps, Money Magazine and many others. This network operates similarly to the Associated Press or Reuters, except we focus almost exclusively on issues relating to personal finance. These are not advertorial or paid placements, rather we provide these articles to our partners in most cases for free. These relationships create more awareness of Credit.com in general and they result in more traffic to us as well.

Our Business Model

Credit.com’s journalism is largely supported by an e-commerce business model. Rather than rely on revenue from display ad impressions, Credit.com maintains a financial marketplace separate from its editorial pages. When someone navigates to those pages, and applies for a credit card, for example, Credit.com will get paid what is essentially a finder’s fee if that person ends up getting the card. That doesn’t mean, however, that our editorial decisions are informed by the products available in our marketplace. The editorial team chooses what to write about and how to write about it independently of the decisions and priorities of the business side of the company. In fact, we maintain a strict and important firewall between the editorial and business departments. Our mission as journalists is to serve the reader, not the advertiser. In that sense, we are no different from any other news organization that is supported by ad revenue.

Visitors to Credit.com are also able to register for a free Credit.com account, which gives them access to a tool called The Credit Report Card. This tool provides users with two free credit scores and a breakdown of the information in their Experian credit report, updated twice monthly. Again, this tool is entirely free, and we mention that frequently in our articles, because we think that it’s a good thing for users to have access to data like this. Separate from its educational value, there is also a business angle to the Credit Report Card. Registered users can be matched with products and services for which they are most likely to qualify. In other words, if you register and you find that your credit is less than stellar, Credit.com won’t recommend a high-end platinum credit card that requires an excellent credit score You’d likely get rejected, and that’s no good for you or Credit.com. You’d be no closer to getting a product you need, there’d be a wasted inquiry on your credit report, and Credit.com wouldn’t get paid. These are essentially what are commonly referred to as "targeted ads" in the world of the Internet. Despite all of this, however, even if you never apply for any product, the Credit Report Card will remain free, and none of this will impact how the editorial team reports on credit and credit scores.



Your Stories

Lastly, much of what we do is informed by our own experiences as well as the experiences of our readers. We want to tell your stories if you’re interested in sharing them. Please email us at story ideas [at] credit [dot] com with ideas or visit us on Facebook or Twitter.

Thanks for stopping by.

- The Credit.com Editorial Team