Before getting to know about the factors influencing interest rates, let’s talk about what they are. It is the price for borrowing money and on the other hand, it is the payment for the risk of lending the money to the borrower. The price paid for borrowing the money is known as “Interest” and the borrowed money is known as the “Principle”. Through this process, the economy keeps moving. It varies from place to place. There are different types of loans and all of them offer different interest rates. They keep on changing and various factors influence them
Factors Influencing Interest Rates:
Let us look at the 5 factors that affect the Interest Rate Levels
Demand and Supply:
When there is more deman for loans and credits then the rates increases and it decreases when the deman for loan and credits decreases. Reciprocally, when the supply of loans and credits is increase the rate decreases, and it increases when the supply of loans and credits decreases. The supply of credit is increased when people invest more in banks. If people open a certificate deposit bank account then they use it to invest in businesses and other investment activities. By earning from the businesses, the bank can lend money to the borrowers.
This increases the supply which decreases the interest rates and improves the performance of the economy. These rates increase when the borrower postpones paying their bills. By delaying this, not only their amount of interest keeps on increasing but there is also a decrease in credit in the market. The decrease in the amount of credit available in the market increases the interest rates.
In a healthy economy, it is considered acceptable and completely fine when there is a moderate rise in inflation. It promotes business activity and does not bother the consumers. When there is a sudden spike in inflation or it suddenly becomes low then it is not at all good for the economy. When inflation rises more than the income of people then they have to cut down their consumption of various services and goods which affects the businesses. On the contrary, due to lower inflation, there are low chances for new startups to grow and there are fewer jobs for people. The rates rise when inflation is high. Inflation affects the rates as the lenders demand security and reimbursement for the risk they are taking by lending them money.
When a country is flourishing with a growing economy, then the people are more confident to invest and spend money. They take loans to invest in a business or purchase a house, a car, or anything else. In a growing economy, there is more demand and supply of credit and loans which decreases the interest rates. When the economy is not growing and it is slowing down, then the people are more concerned about their finances and they are reluctant to spend money and invest which increases the rates.
When there are fewer jobs for people and unemployment keeps rising, then it affects the economy. It is a sign that employers are unable to afford more employees. Due to unemployment, people have to cut down their consumption of goods and services as they do not have enough money. The people do not have enough money to open a bank account or lend money from the banks which results in less amount circulating and lesser businesses. High unemployment increases interest rates. When there are more job opportunities and people are earning more, then they invest and spend money which helps in the growth of the economy and the decrease in interest rates.
When the government buys additional resources and securities, then banks receive more money so they can lend it to the borrowers and invest in businesses. This helps in decreasing interest rates. When the government sells the resources and securities, then the money is taken out from the banks and there is not much to lend to the people which increases the interest rates.
These were the 5 major factors and everyone should know about them. This knowledge is necessary for everyone so that people can draft their financial plans and take steps to improve their lives. To improve your life and plan finances it is necessary to take steps in the early stages. During university life, plans should be made and steps should be taken. Students take student loans to afford their studies and to build a better future for themselves.
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