An interest rate is the cost of borrowing money or the reward for saving it, expressed as a percentage of the principal per year.
Types
- Nominal rate: The stated rate before adjusting for inflation
- Real rate: Nominal rate minus inflation
- Effective rate: Accounts for compounding frequency
Who Sets Rates?
The Federal Reserve sets the federal funds rate, which influences all other rates. When the Fed raises rates, borrowing costs increase but savings accounts earn more.
Fixed vs. Variable Rates
A fixed rate never changes for the life of the loan or deposit, giving payment certainty. A variable (or adjustable) rate moves with a benchmark index (like the prime rate or SOFR), which can save money when rates fall but adds risk when they rise — relevant for ARMs, HELOCs, and many credit cards.
How the Fed Affects Your Rate
The Federal Reserve doesn't set consumer loan rates directly — it sets the federal funds rate that banks charge each other overnight. Mortgage, auto, and credit card rates are priced off that baseline plus a margin for risk and profit, which is why they move (with a lag) when the Fed changes policy.