Ever thought interest rates were a bit, um, uninteresting?
The interest rate is just another way of talking about the cost of money. Strange to talk about money costing something, eh? Surely £100 can only be £100, it can’t be £120?
But, say you lent a friend some money. Wouldn’t it be nice if your friend gave it back a few weeks later plus a little bit more to make up for the fact that you couldn’t spend it yourself?
That “little bit more” would be called the interest. The amount of interest is usually calculated as a percentage, and that’s called the interest rate.
Banks work in exactly this way. When we open a bank account and deposit some money, in a way we are letting the bank borrow our money. So the bank pays us interest. The higher the interest rate the more money the bank pays.
And when we borrow money from banks, we pay interest to the bank.
When the interest rate goes up, people who borrowed money have to pay more, and when it goes down they pay less.
When interest rates are low we don’t like to put our money in the bank because we don’t get as much back. So we look for other places to spend or save our money. But when interest rates are high, we are more tempted to save, because we get more money from the bank.
We’ll borrow tens or even hundreds of thousands of pounds to buy a house. Sometimes even millions of pounds.
When we borrow money to buy a house it’s called a mortgage.
Because the amount being borrowed for a house is so big, even the smallest change in the interest rate can make a big difference. If the interest rate changes by just 0.25% it can mean hundreds or thousands of pounds difference in the amount one has to pay.
At the moment, for instance, interest rates for mortgages are at 3.5% - their lowest since 1955.
But remember, whatever the interest rate, it’s always better to save a £ and you’d be surprised how the money can mount up.
Dom is a journalist and business editor of New Media Age