In the financial world, there are two kinds of people. Those who, through ignorance, allow Interest rates to keep them in a state of penury and those who use it to their advantage. Dan Schulman confirmed this in a quote that said, “On average, an underserved consumer spends 10% of their disposable income on unnecessary fees and interest rates”.
A lack of understanding of how interest rates work while you save money in the bank, secure loans, invest or pay for expenses can either reward or punish you financially.
To a layman, Interest is the price you pay for the temporary use of someone else’s funds. The rate of Interest, or Interest rate, is the percentage of the money (borrowed) that is attributable to interest. Whether you lend or borrow money, it is important to consider how interest rates are changing so you make wise decisions in the area of finances.
Why Do Lenders Charge Interest?
One of the ways people accomplish their financial goals is through Debt, and the price you pay for borrowing money is Interest. Any person or organisation who gives you a loan knows he or she will be compensated with interest for the service and risk of lending money.
A well-known risk is that the borrower may not pay back the loan as at when due. Another risk the lender assumes is Inflation. The prices of goods and services would have gone up by the time the lender is paid back his or her money. As such, the purchasing power of that money is reduced due to Inflation. Therefore, Interest paid on loans help to mitigate risks such as Inflation or borrower’s risk.
How Are Interest Rates Determined?
In Nigeria, the Federal government through monetary policies uses interest rates to control money and credit conditions in the economy. They buy or sell government securities, such as Bonds or Treasury Bills, which affects the federal funds rate. So Banks and other lending organisations who deal with funds capitalise on this to determine the rates they give you as interests on loans.
For example, when the Federal government sells Bonds or TBills, these transactions are done through the money in banks. Therefore, fewer funds are available to be given as loans, which leads to high-interest rates. On the other hand, when the government buys securities, these Financial institutions receive more money which can be given to people as loans. This increase in the supply of credit leads to low-interest rates.
Interest rate is also used by central banks in order parts of the world to manage the macro-economy. Rising rates makes borrowing more expensive and slows economic growth while cutting rates encourages cheaper credit and borrowing.
How Interest Rates Affect Our Finances
Low-interest rates will discourage you and I from saving money in the Bank. Interest rate is the reason why many people are drawn to save and invest using platforms like Piggyvest and Cowrywise. They promise higher interest rates which make saving with them more attractive than the Banks. Thus, interest rates can affect an individual saving culture.
More people are inclined to accept loans to solve specific challenges if the interest rate is low. An individual who wants to invest in a business will be discouraged from borrowing if the interest is high.
If the policy on money is hostile to citizens then the economy will experience a decline. This will keep interest rates high, and less cash in circulation for people. A decline in the economic growth of a nation will affect the level of income earned because people will have less cash to survive on.
The Bottom line is …
Interest rates affect how save, spend, invest and earn money. It also affects banks, government, companies, individuals, Non-profits, traders, importers, exporters. When interest rates are high, the economy shrinks. This can lead to a recession if it continues. The opposite happens when there’s a boom in economic growth. More money is in circulation.
However, low-interest rates can create inflation as too much money seem to be chasing too few goods. It is the responsibility of the government to control inflation and manage recession. We encourage you to stay informed about what’s happening in terms of a rise or fall in interest rates. This will help you reduce your risks when accepting loans, saving, investing (especially, in stocks or bonds) and making payments through credit cards.