Interest rate facts for kids

An interest rate is like a fee you pay when you borrow money, or a payment you get when you lend money. It's usually shown as a percentage of the total amount.

For example, if you borrow $100 with a 10% interest rate, you'll pay back the original $100 plus an extra $10 (which is 10% of $100). So, you pay back a total of $110.

In most countries, a special bank called a central bank sets a main interest rate, often called the base rate. This base rate helps guide all the other interest rates that banks offer to businesses and people. The rates you see for loans or savings are always a bit higher than this base rate.

What is an Interest Rate?

An interest rate is basically the cost of borrowing money or the reward for saving it. When you borrow money, you don't just pay back the amount you borrowed; you also pay an extra amount called interest. This interest is the lender's profit for letting you use their money.

Why do we have Interest Rates?

Interest rates are important because they help control how much money is moving around in an economy. If interest rates are low, borrowing money is cheaper, so people and businesses might borrow more to spend or invest. If rates are high, borrowing is more expensive, which can slow down spending.

How is Interest Calculated?

Interest is usually calculated as a percentage of the principal amount (the original money borrowed or saved). For example, if you borrow $500 at a 5% interest rate per year, you would owe $25 in interest for that year ($500 x 0.05 = $25).

Who Sets Interest Rates?

In most countries, a special bank called the central bank is in charge of setting the main interest rate. This is often called the base rate or policy rate.

What is a Central Bank?

A central bank is like the main bank for a country's government and other banks. It doesn't usually deal with regular people like you or me. Its main jobs include keeping prices stable, making sure banks are safe, and managing the country's money supply.

How does the Base Rate Affect You?

When the central bank changes the base rate, it affects all other interest rates in the country.

• If the base rate goes up, banks will charge more for loans (like for houses or cars) and might offer more interest on savings accounts.
• If the base rate goes down, loans become cheaper, and savings accounts might earn less interest.

Types of Interest Rates

There are different kinds of interest rates depending on what you're borrowing or saving for.

Savings Interest Rates

When you put money in a savings account at a bank, the bank pays you interest. This is because you are essentially lending your money to the bank, and they pay you for using it. The higher the interest rate, the more money your savings will earn over time.

Loan Interest Rates

When you borrow money for things like a house (a mortgage), a car, or even a credit card, you pay interest to the lender. This is the cost of borrowing that money. Different types of loans have different interest rates based on how risky the loan is and how long you have to pay it back.

Why Interest Rates Change

Interest rates don't stay the same forever. They can change based on several things happening in the economy.

Inflation

Inflation is when prices for goods and services go up over time, meaning your money buys less than it used to. Central banks often raise interest rates to try and slow down inflation. If borrowing is more expensive, people might spend less, which can help prices stabilize.

Economic Growth

If the economy is growing strongly, people might be spending a lot and businesses might be expanding. In such times, central banks might raise interest rates to prevent the economy from overheating. If the economy is slowing down, they might lower rates to encourage spending and investment.