Interest rates aren't just a concept you learned (and promptly forgot) in Econ 101—they directly affect your day-to-day life. Whether you're taking out a loan, buying a car, or saving money, understanding how interest rates work can help you make smarter financial decisions. 

With inflation shifting and interest rates responding, it's more important than ever to know how these forces shape your spending, savings, and overall financial health.

Let’s break it down

Before diving into how interest rates impact your wallet, let’s first break down what interest actually is. 

• Interest is the cost of borrowing money. When you take out a loan, you pay interest to the lender on top of the money you borrowed (a.k.a. the principal). 
• On the flip side, if you put your money in certain types of accounts, you can earn interest. 
• How much you pay or earn is determined by the interest rate. The higher the interest rate, the more you pay (when borrowing) or earn (when saving).

In the U.S., the Federal Reserve sets a baseline interest rate that influences nearly all other rates in the economy. They meet eight times a year to adjust this baseline, but the rates can fluctuate more often, especially for things like mortgages. As Vox^[1] explains in the video below, these changes are tightly connected to inflation and spending habits:

How does this affect you?

Interest rates influence almost every aspect of your financial life:

• Loans: Higher rates mean more expensive loans for cars, homes, and credit cards. When interest rates are low, it’s cheaper to borrow, so it might be a better time to make larger purchases like a home or car.
• Savings: Higher interest rates encourage saving because you’ll earn more from savings accounts. Conversely, when rates are low, your money grows slower.‍
• Jobs: High interest rates typically mean higher costs for businesses, which can lead to fewer new jobs or even layoffs. Lower rates reduce costs for businesses, which can stimulate hiring and create a more competitive job market.

Compound interest: friend or foe?

If you have a loan or savings account with compound interest, even a small difference in interest rates can have a big impact over time. The difference between a 2% and a 6% interest rate could mean thousands of dollars in your pocket - or out of it!

Compound interest is when interest is calculated on both the initial amount (the principal) and the previously accumulated interest. For savers, this translates into growing your savings faster; for borrowers, it means paying interest on interest, causing debts to grow faster over time.

For example, leaving a $500 balance on your credit card with a 10% monthly interest rate results in $50 dollars owed in interest alone. If you leave the balance for another month, you’ll then owe $55 interest on the new $550 balance. 

If we go back and crunch the numbers with an interest rate of 30%, the interest owed in that second month jumps up to $195!

Payday lenders often capitalize on high interest rates, and short term loans usually compound more frequently—weekly or monthly—causing debt to grow more rapidly. 

🧠 Good to know: Not all lenders charge interest. For example, because Exhale partners with employers to safely access paycheck data and calculate personalized repayment schedules, we are able to offer short-term advances at 0% interest.

Making interest rates work for you

Whether interest rates are high or low, there are ways to make them work in your favor^[2]:

When rates are high:

• Shop for high-yield savings accounts to maximize your returns when you save

• Focus on paying down high-interest debt to avoid the debt trap

When rates are low:

• Take advantage of cheaper loans for large purchases, but be mindful of your budget
• Continue saving, even if returns are lower (building a cushion is always smart!)
• Make strategic investments that can benefit you in the long run

🗝️ Key takeaway: Interest rates play a major role in your financial health, no matter your income level. By understanding how they work, you can make better decisions about when to save, when to borrow, and how to plan for your financial future. So keep an eye on those rates and make them work for you!