What are Interest Rates? | Ask an Economist?

Interest rates are like the price you pay to borrow something from your friend, or the reward you get for letting them use it.

Imagine you have a piggy bank full of candies. If you want more candy now, but don’t have any, you can ask your friend to lend you some. In return, you might promise to give them extra candy later. The extra candy is like interest, and the amount you agree on is the interest rate.

If you borrow money from a bank, they might say, "We’ll let you have this money now, but you need to pay us back a little extra each month." That extra bit is the interest, and the percentage they charge is the interest rate.

Sometimes, if you save your money in the bank instead of borrowing, the bank might give you extra candy (or money) as a thank-you, that’s also interest!

Banks use interest rates to decide how much people should pay for loans or how much they’ll reward savers. When interest rates go up, it costs more to borrow; when they go down, borrowing gets cheaper, just like trading candies with your friend!