Borrow a thousand dollars and you pay back more than a thousand. Lend it out and you earn extra. That extra, expressed as a percentage of the original sum, is the interest rate. It is the price of money over time, and it shapes nearly every financial decision a person or business makes.

Central banks set a benchmark rate, the rate at which commercial banks borrow from each other or from the central bank itself. Mortgage rates, credit card rates, and savings account yields all cluster around that benchmark, rising and falling with it. When the Federal Reserve raises rates, car loans get pricier within weeks. When it cuts, the reverse happens, though not always as fast.

Two forces drive rates: the supply of loanable funds and the demand for them. Governments borrowing heavily push rates up. High inflation pushes them up too, because lenders demand compensation for lost purchasing power. A sluggish economy with weak demand pushes them down. The interaction is constant, and the result is a rate that changes daily.

Types of interest rates

• Nominal rate: the stated rate before inflation
• Real rate: nominal rate minus inflation
• Prime rate: benchmark for commercial loans
• Federal funds rate: rate for overnight bank lending
• APR: annual percentage rate on consumer loans