Glossary
Interest rate
The price of borrowing money, stated as a yearly percentage of the amount borrowed, and the return paid to savers and lenders.
An interest rate is the price of using someone else's money, expressed as a percentage of the amount borrowed per year. The borrower pays it and the lender or saver earns it. Rates matter well beyond loans: they set the return on cash and bonds, the cost of capital for companies, and the discount rate investors use to value future profits, so a change in rates ripples through almost every asset price.
How interest is calculated
Simple interest applies the rate to the original principal only. Compound interest applies it to the principal plus interest already earned, so the effective yearly return rises with how often interest is added.
Nominal versus real
The quoted rate is the nominal rate. Subtracting inflation gives the real rate, which measures the gain in purchasing power: a 5% savings rate with 3% inflation is roughly a 2% real return, while 5% with 6% inflation loses ground.
Who sets interest rates
No single body sets them all. In the US the Federal Reserve targets the federal funds rate, an overnight rate between banks, and that anchors short-term rates on savings accounts, Treasury bills and credit cards. Longer-term rates, such as the 10-year Treasury yield and mortgage rates, are set in the bond market by expectations of future short rates, inflation and risk. Borrowers with weaker credit pay a premium over those benchmarks.