A lender’s interest rate is the percentage of principal charged for the usage of its money. The amount of money loaned is referred to as the principle.
Interest rates influence loan costs. As a result, they can either accelerate or slow the economy. The Federal Reserve controls interest rates in order to ensure optimal economic growth.
What Are Interest Rates?
The interest rate determines the cost of borrowing money or the reward for saving it. It’s expressed as a percentage of the amount borrowed or saved.
You borrow money from a bank when you get a house mortgage. Other loans can be used to finance the purchase of a car, an appliance, or college tuition. Banks borrow money from you in the form of deposits, and the interest rate they pay you is what you get in return for depositing money. Deposit funds are used to finance loans.
Borrowers pay a higher rate of interest than depositors. The difference is their profit. Interest rates remain within a narrow range because banks compete for both depositors and borrowers.
How Do Interest Rates Work?
The interest rate is applied to the entire unpaid amount of your loan or credit card debt by the bank, and you are required to pay at least the interest in each compounding period. If you don’t, even if you are making payments, your outstanding debt will increase.
Although interest rates are competitive, they are not all the same. If a bank believes there is a slighter possibility of the debt being returned, it will charge a higher interest rate. As a result, banks will often charge a higher interest rate on revolving loans, such as credit cards, because they are more expensive to maintain. Banks also charge higher interest rates to those they consider to be high-risk.
High VS. Low-Interest Rates
Loans are more expensive when interest rates are high. People and businesses can’t afford to borrow when interest rates are high. As a result, the quantity of credit available to support purchases is reduced, causing consumer demand to decline. Simultaneously, it encourages more individuals to save by providing a higher return on their savings rate. High-interest rates can limit the amount of money available for corporate expansion, suffocating supply. The economy is slowed as a result of the decrease in liquidity.
Interest rates that are too low have the opposite effect on the economy. Low mortgage rates stimulate real estate demand in the same way that lower housing prices do. Saving rates fall. When savers find that their accounts are earning less interest, they can decide to spend more. They might even engage in somewhat riskier but more profitable investments, causing stock values to rise.
Low-interest rates can cause inflation. Demand outstrips supply when there is too much liquidity and prices increase. This is only one of the reasons that cause inflation.
Inflation Rates and Cryptocurrencies
Traders in the cryptocurrency market are giving careful attention to interest rate predictions and recent rises because of concerns that Central Bank rate hikes would weaken Bitcoin’s appeal, which is already weakening amid the crypto winter.
The Federal Reserve started off what was expected to be a series of raising rates in March. The US Federal Reserve raised its base rate for the first time in four years, though just by a quarter of a percentage point. When it comes to the future of interest rates, there is a lot of uncertainty right now. The coronavirus pandemic is still causing chaos in major economies, and Russia’s invasion of Ukraine has added to global tensions.
Before the invasion, inflation had already reached dangerously high levels, with the US Consumer Price Index (CPI) reaching 7.9% in February. The situation has been compounded significantly by rising energy prices. The Federal Reserve raised its key interest rate by three-quarters of a percentage point on June 15th, the largest increase since 1994. At the same time, the Dow Jones was down 765 points and the S&P 500 was down 3.4%.
What If Interest Rates Increase?
Bitcoin was created from the ashes of the financial crisis of 2007/08, and its network went live in January 2009. This means that the world’s largest cryptocurrency has profited from an era of ultra-low interest rates for most of its life.
It’s tough to determine how much impact interest rates will have on crypto. Demand for BTC could likely diminish if interest climbs, luring investors away from digital assets in favor of traditional savings accounts, which provide higher returns with lower risk.
There is also one more factor to consider: BTC’s correlation to the stock market is at an all-time high. This implies the digital asset moves in lockstep with the S&P 500, falling and rising simultaneously.
Takeaways
- The cost of borrowing money or the reward for saving it is known as the interest rate.
- The interest rate is applied to the entire unpaid loan amount by the bank, and you are required to pay at least the interest in each period.
- Loans are more expensive when rates are high.
- Low-interest rates are not good either because they can cause inflation.
- If interest rates increase it can have a negative impact on cryptocurrencies, especially Bitcoin.
