WTF are Interest Rates? Are They Really That Interesting?
An easy to follow guide to Interest Rates.
IKYMI, I started a new “Real Talk” segment where we can talk about subjects that normally make you feel like glazing over with boredom. You know, those subjects you are pretty sure you learned about in school but weren’t paying attention, and now you’ve gotten this far and are embarrassed to tell anyone you don’t actually know what the deal really is?
Today’s topic: WTF are Interest Rates? And are they really that interesting because I’m already feeling kind of bored just thinking about them…
WTF Are Interest Rates Again?
OK, SO THE GOAL HERE IS TO KEEP THIS AS PAINLESS AS POSSIBLE. WE’RE NOT GOING TO DIVE INTO DIFFERENT TYPES OF INTEREST RATES OR TALK ABOUT INFLATION AND HOW RENT PRICES ARE RISING… ONCE AGAIN, THAT WILL JUST MAKE MOST OF US HIT THE SNOOZE BUTTON. WE’RE GOING FOR QUALITY NOT QUANTITY.
IN SIMPLE TERMS (AKA ERIN TALK), INTEREST IS THE PRICE YOU HAVE TO PAY TO BORROW MONEY.
SO, THE AMOUNT OF MONEY ITS GOING TO COST YOU ON TOP OF BORROWING MONEY. THIS COULD BE IF YOU TAKE OUT A LOAN FOR COLLEGE, BUY A HOUSE, GET A CREDIT CARD, ETC.
WHEN YOU BORROW MONEY, MOST OF THE TIME YOU’RE GOING TO HAVE TO PAY BACK WHAT YOU BORROWED. PLUS THE COST OF BORROWING THAT MONEY – USUALLY A PERCENTAGE OF THE LOAN.
THINK: YOUR BIG BROTHER HAS A LOT OF MONEY AND YOU WANT TO BUY A NEW BIKE. SO YOU ASK IF YOU CAN BORROW $50. HE’S LIKE, SURE YOU CAN… BUT IT’S GONNA COST YOU. I MEAN, MAYBE YOU HAVE A SUPER COOL BROTHER WHO JUST GIVES YOU THE MONEY, BUT MOST OF THE TIME, HE’S GOING TO CHARGE YOU A “FEE” FOR USING THAT MONEY. AND THAT, IS INTEREST.
I USED TO TELL MYSELF THIS LITTLE STORY TO REMEMBER WHAT IT MEANT. AND THOUGHT ABOUT THE FACT THAT IF I WANTED TO KEEP MY OLDER BROTHER “INTERESTED” IN HELPING ME, HE’D PROBABLY WANT SOMETHING OUT OF THE DEAL.
HOW DO I AVOID INTEREST?
WELL, THE EASIEST WAY TO AVOID INTEREST IS BY NOT TAKING OUT A LOAN. OR NOT USING CREDIT. BUT THAT’S NOT ALWAYS POSSIBLE.
IF YOU PAY YOUR CREDIT CARD BALANCE IN FULL (MEANING YOU PAY THE WHOLE AMOUNT WHEN IT’S DUE), YOU WON’T HAVE TO PAY THE INTEREST CHARGE.
THERE ARE ALSO A LOT OF PROMOTIONAL LOANS AND CARDS THAT OFFER 0% INTEREST RATES FOR A LIMITED TIME. FOR EXAMPLE, A LOT OF FURNITURE COMPANIES WILL OFFER YOU “0% INTEREST” ON YOUR PURCHASE IF YOU PAY OFF THE BALANCE WITHIN A YEAR. OR A CREDIT CARD WILL HAVE AN INTRODUCTORY 0% INTEREST RATE ON BALANCE TRANSFERS AND PURCHASES FOR A SET NUMBER OF MONTHS.
THE AMOUNT OF INTEREST YOU PAY, OR THAT PERCENTAGE RATE YOU ARE CHARGED WILL VARY DEPENDING ON A LOT OF DIFFERENT FACTORS.
SOME LOANS HAVE “FIXED INTEREST RATES”, MEANING THE % RATE YOU’RE CHARGED STAYS THE SAME.
SOME LOANS HAVE “VARIABLE INTEREST RATES”, MEANING THE % RATE CAN CHANGE. THERE’S A LOT MORE THAT GOES INTO THAT OBVIOUSLY, BUT IT’S HELPFUL TO KNOW THAT THERE ARE DIFFERENT OPTIONS AND THEY ALL HAVE PROS AND CONS.
WHAT DO INTEREST RATES MEAN?
IF INTEREST RATES ARE HIGH (A TERM YOU PROBABLY SEE IN THE NEWS A LOT), IT MEANS IT COSTS MORE MONEY TO BORROW MONEY.
IF INTEREST RATES ARE LOW, IT COSTS LESS TO BORROW MONEY.
THINK: IF YOU NEED TO BORROW $50, YOU’D RATHER GET CHARGED A LOWER % RATE, RIGHT?
SO YOU CAN SEE WHY IT’S IMPORTANT TO UNDERSTAND WHAT INTEREST RATE YOU’RE AGREEING TO PAY BEFORE GETTING A LOAN. BECAUSE IN THE LONG RUN, THAT INTEREST RATE IS WHAT DETERMINES HOW MUCH MONEY YOU’RE GOING TO ACTUALLY OWE.
ANOTHER IMPORTANT WAY TO LOOK AT – IF YOU DON’T PAY OFF YOUR CREDIT CARD BALANCE EVERY MONTH, YOU’RE GOING TO KEEP GETTING CHARGED INTEREST. MEANING YOUR DEBT KEEPS INCREASING. JUST BECAUSE YOU’RE NOT SPENDING ANY MORE, DOESN’T MEAN YOU’RE NOT GOING TO KEEP GETTING CHARGED MORE.
THE MORE DEBT YOU HAVE, THE LESS CREDIT YOU WILL MOST LIKELY HAVE AVAILABLE. BASICALLY, THERE’S A MAXIMUM AMOUNT OF CREDIT AVAILABLE TO EVERYONE. AND IF YOU’RE USING ALL OF YOURS, NOT ONLY IS THERE NO MONEY LEFT TO BORROW, BUT YOUR CREDIT SCORE WILL BE AFFECTED.
OK SO YOU’RE PROBABLY THINKING… I JUST WANTED TO KNOW WHAT AN INTEREST RATE WAS, WHY ARE WE TALKING ABOUT CREDIT SCORES? I’M FADING FAST DOC. I CAN’T LEARN ANY MORE.
WELL, YOUR CREDIT SCORE WILL DETERMINE THE INTEREST RATES YOU’RE OFFERED. SEE, IT’S LIKE IT’S ALL COMING BACK AROUND AND WORKS TOGETHER.
I KNOW IT’S KIND OF CONFUSING. THERE’S A LOT THAT GOES INTO IT ALL. BUT IF YOU’RE ASKING BIG PICTURE QUESTIONS, IT’S IMPORTANT TO REMEMBER:
- INTEREST IS WHAT YOU’RE CHARGED TO BORROW MONEY
- AN INTEREST RATE IS THE % YOU’RE CHARGED TO BORROW MONEY
- IT’S IMPORTANT TO PAY OFF LOANS, INCLUDING THE INTEREST YOU’RE CHARGED
- THE MORE MONEY YOU OWE, THE LESS MONEY AVAILABLE YOU’LL HAVE TO BORROW
- IF YOU’VE MAXED OUT CREDIT SCORES AND ARE ALWAYS LATE PAYING BACK LOANS, LENDERS WILL (GENERALLY) CHARGE YOU MORE TO BORROW MONEY. AKA, HIGHER INTEREST RATES.
- IF YOU ARE GOOD AT PAYING OFF LOANS AND DEBT, LENDERS WILL (GENERALLY) CHARGE YOU LESS TO BORROW MONEY. AKA, LOWER INTEREST RATES.
- IT’S HARD TO AVOID INTEREST RATES WHEN YOU’RE BORROWING MONEY, SO IT’S A GOOD IDEA TO SHOP AROUND AND UNDERSTAND THE “COST OF YOUR MONEY”
DEEP CUT: WHAT IS AN APR?
OK, IF YOU’RE STILL ON BOARD WITH ALL OF THIS INTEREST RATE TALK AND WANT TO ADD ANOTHER PIECE TO THE PUZZLE, KEEP READING.
YOU MIGHT HAVE HEARD THE TERM “APR”. AND IT’S JUST ANOTHER TERM YOU’LL SEE WHEN BORROWING MONEY.
APR IS A TYPE OF INTEREST RATE – IT’S YOUR INTEREST RATE FOR AN ENTIRE YEAR, RATHER THAN JUST A MONTHLY RATE OR FEE. AN ANNUAL PERCENTAGE RATE (APR) IS THE TOTAL COST YOU’LL SEE FOR HAVING A LOAN OR CREDIT CARD.
THE APR IS A HELPFUL NUMBER BECAUSE IT MAKES IT EASIER TO COMPARE LOANS AND LENDERS. WHEN YOU HEAR ABOUT A LOAN’S APR, IT’S GOING TO BE THE TOTAL COST YOU HAVE TO PAY BECAUSE IT COMBINES HTINGS LIKE YOUR INTEREST RATE AND OTHER FEES.
EXAMPLE: IF YOU BUY A HOUSE, THE APR OF YOUR MORTGAGE WILL INCLUDE YOUR INTEREST RATE AND FEES LIKE MORTGAGE BROKER AND LENDER FEES. THIS HELPS YOU SEE THE BIGGER PICTURE OF WHAT YOU’RE GOING TO OWE, MAKING IT EASIER TO MAP OUT WHAT YOU CAN AFFORD.
INTEREST RATES POP UP EVERYWHERE FROM STUDENT LOANS TO REAL ESTATE. DISREGARD ALL OF THE CONFUSING TERMS LIKE SHORT TERM INTEREST, FIXED RATES, RISING INTEREST RATES, NOMINAL RATES & EFFECTIVE RATES… FOR NOW, JUST RELISH IN THE FACT THAT YOU CAN DROP SOME GENERAL INTEREST RATE TERMINOLOGY ON YOUR FRIENDS AND FAMILY!
HOPEFULLY THIS WAS HELPFUL! IF YOU MISSED THE LAST POST, YOU CAN LEARN WTF A ROTH IRA IS HERE!
