Interest rates have gotten a lot of attention lately. After languishing at historically low levels for years, the Federal Reserve recently has begun raising interest rates to combat inflation.
Higher rates can pose a problem if you’re working to ways to crush your debt. But there are many other ways that interest rates impact our daily lives.
Following are 17 facts you might not know about interest rates.
You probably have more than one rate on your credit card
The interest rate you pay varies from credit card to credit card, but can also change on a single card based on what you use the card for.
For example, your interest rate for a cash advance or balance transfer is probably different from the rate you pay when you use the card to make a purchase.
Pro tip: You can use this to your advantage by strategically making purchases with one of the best low-interest credit cards and paying off the balance before the intro APR ends.
Credit card interest rates change for many reasons
Your credit card interest rate can shift for many reasons. For example, the interest rate on a card may change for reasons as varied as:
- You are late with a payment by 60 days or more
- An introductory rate expires
- The bank decides to raise rates for all customers
Credit card interest rates are variable
Typically, credit card interest rates are variable. Banks use the prime rate to determine the cost of borrowing they charge to their most creditworthy customers.
Although the Federal Reserve doesn’t set the prime rate, any changes the Fed makes in its federal funds rate will influence the rates banks attach to loans or credit cards.
Interest rates are usually negotiable
If you feel your interest rate is too high, call the lender and try to negotiate. While you might not get the very best deal, you sometimes can lower your rate a little.
If negotiating doesn’t work, shop around for the best balance-transfer cards with an introductory rate of 0% to help stop interest from accruing while you pay down debt.
Your credit score affects your interest rate
Credit card interest rates are based partly on your credit score and your financial stability. The higher your credit score, the less of a risk you pose to the bank.
So, keep an eye on your score and do what you can to improve it. Actions like paying your bill on time, using credit responsibly, and not applying for multiple credit cards all at once can help improve your score.
Higher interest rates can cost you more — or reward you
When a bank makes a loan, it adds interest to your principal balance. You are responsible for paying both the principal and the interest charged. Over time, this interest charge costs you additional money.
On the other hand, when you save money in a savings account, the opposite happens. The bank pays you interest for depositing your money with them. This helps you make money.
In other words, rising interest rates can either hurt you or help you, depending on whether you are borrowing or saving.
Pro tip: Not all savings accounts are the same. The best savings accounts are known as “high yield” accounts and they can pay a lot more interest.
Fixed interest rates may still fluctuate
A fixed interest rate does not move up and down due to underlying changes in an index. However, that does not mean it never can change.
If a lender decides to adjust the rate, it simply must notify you in advance of any changes. Generally, though, the new rate only can apply to charges you incur after you are notified of the rate change.
Interest may keep accruing on student loans, even in deferment
One of the painful truths about student loans is that they can continue to accrue interest, even when you have a deferment.
A subsidized student loan — where the government pays the interest on your loan during specific times, such as when you attend school at least half-time — offers an exception to this rule.
Pro tip: Want to spend less on your student loan repayments? Check out the best student loan refinance companies.
Today’s interest rates remain far lower than in earlier times
In the early 1980s, the federal funds rate rose to 20%. Paul Volcker, who was then the Fed chair, tried to combat runaway inflation by raising rates several times throughout 1980 and into 1981. As a result, the country saw some of its all-time highest interest rates.
The effort worked, as Volcker broke the back of inflation, which remained much lower for decades after.
Rising interest rates don’t automatically boost savings accounts
Usually, savings account rates increase as the federal funds rate rises. And at many banks, that is happening now.
But not everywhere. Research competing banks to see if you may be able to find a better savings account interest rate by moving your money to a new bank.
Simple interest earns less than compound interest
Simple interest is calculated based solely on the principal amount. Compound interest is based on the original principal balance and accumulated interest.
For an account with a $10,000 balance and a 4% interest rate, you would earn $400 each year in simple interest, year after year.
By contrast, compound interest on the same account would result in a higher payout with each new year, since the interest is based on both the principal and the accumulated interest. So, you would earn $416 in the second year, $432.64 in the third, and so on.
How often your interest rate compounds matters
Interest doesn’t always compound annually. Many credit card companies calculate interest charges using a daily periodic rate. This means higher costs for you over the time it takes to pay back the debt.
Check your credit card agreement or loan paperwork to verify how interest is calculated. Even a slight difference in compounding can significantly affect how much you pay.
The Federal Reserve does not set mortgage interest rates
The Fed does not set mortgage rates but its policy actions do influence home loan interest rate movements. Generally, the federal funds rate and mortgage rates move in the same direction, but they are not directly linked.
The bond market and other factors help determine where mortgage rates go. However, as history has shown, it is difficult to forecast changes in mortgage rates precisely.
Pro tip: You can find the best rates on the market by shopping for the best mortgage lenders.
The interest rate is different than the APR on a mortgage
The interest rate on a mortgage is the amount you pay each year to borrow money, communicated through a percentage. The annual percentage rate (APR) includes other costs. Examples are any points, mortgage broker fees, and other charges that go into a loan.
Note that APRs on adjustable-rate mortgages don’t reflect the maximum interest rate possible on the loan. Do your homework and understand your loan agreement fully before signing.
The Federal Reserve cut interest rates to almost zero in 2008
The Federal Reserve cut interest rates to almost zero in December 2008, during the Great Recession, and introduced new lending programs. This was supposed to help the financial markets function and stimulate the economy by making borrowing easier.
Rates remained low until the end of 2015 when the labor market had improved and the inflation rate remained steady.
Average mortgage rates peaked in 1981
Although interest rates on mortgages and other forms of borrowing are rising today, they are nowhere near the highs seen in the 1980s.
According to the St. Louis Federal Reserve, the average 30-year fixed-rate mortgage in the U.S. in October 1981 was 18.44%, the highest rate recorded between 1971 and 2022.
Average mortgage rates bottomed in 2021
If the 1980s saw some of the highest average mortgage rates, recent years have seen some of the lowest.
In January 2021, the average 30-year fixed-rate mortgage in the U.S. was 2.65%, according to the Federal Reserve Bank of St. Louis. That marked a low stretching back at least 50 years.
There isn’t much we can do to stop rising interest rates. But knowing how they affect your financial life can help you prepare for them and reduce your money stress.
For example, if you’re worried about interest rates rising on your credit cards, consider a balance transfer card, especially if you can pay off the balance before the introductory period ends.
Now is also a great time to research high-interest savings accounts and make rising interest rates work for you.