what is the purpose of an interest rate?
In: Economics
It’s the cost to borrow money.
If you want to borrow $500k from me to buy a house and want to pay it back over time, I’m going to want an incentive to give you all that money. So you offer to pay back the original $500 principal plus interest. The rate is how much you pay, usually expressed as a percentage of loan amount.
In the U.S., the Fed sets the rate for banks to borrow from the Fed for overnight reserve requirements, and then most other loans are benchmarked to that, eg. Mortgages might be Fed rate + 2%, car loans +3.5%.
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