This article is dedicated to interest rates and what they mean for you as a saver and consumer. Interest rates can be better understood by using the Savings Calculator tab of The Complete Financial Workbook found on the Downloads page.
What is an Interest Rate?
An interest rate is the rate at which your money grows or the rate at which borrowed money is charged to the borrower. Interest rates are found in almost every financial instrument from personal bank accounts, to mortgages, to private equity investments - simply put, interest rates are how individuals or companies that own the money (your money in the bank or the money a bank lended) makes a return. Interest rate are often based on an index, which are typically be treasury yields (https://www.wsj.com/market-data/bonds). Individuals/Companies that own the funds then charge a smaller rate in addition to the index, as the index based on a bond, is seen as a zero-risk investment. The additional fee charged is known as a "spread" and that is essentially the money that the company or individual makes. For the purpose of this article, we are going to focus on interest rates of personal accounts and credit cards.
Saving and Interest Rates
Interest rates impact anyone that has money or is borrowing money. Even if your money is in your mattress, interest rates are impacting you. Let's find out why. The below examples show three different scenarios, someone that saves money with 0% interest (Matt), someone who saves money in a low-yield interest savings account (Lucy), and someone who saves money in a high-yield interest savings account (Houghie). Each person has the same amount saved and will save the same amount at the same intervals, this way we can see how interest impacts savings growth.
Here we see Matt saving $10,000 for ten years at 0% interest. His money did not grow at all, and Matt ends up with $101,000 after 10 years of saving diligently.
Lucy saved her money in a standard savings account, like Wells Fargo, which has a 0.01% annual interest rate. As we can see, this only made Lucy $46 richer after saving the same was as Matt did.
Finally, we see how Houghie's money grew with a 1.50% interest rate, which is typical of high-yield savings accounts like Marcus, Ally, or American Express. After saving the same as Lucy and Matt, Houghie's money earned $8,000 more than both of them thanks to interest.
Over time, interest rates make a huge difference in how much money your savings can earn you. It is important to be selective when choosing a savings account and to look for high-yield savings (and checking) accounts, with zero fees. These types of accounts will put your money to work better than any other savings/checking account available. It should be noted that, if saving for a specified goal, a higher interest rate will decrease the amount of time it takes to reach said goal, as your money grows quicker with higher interest than with low.
Interest Rates and Credit Cards
Credit cards are Americans primary way of purchasing goods, whether it is for necessities or for lavish items a little out of the purchaser's budget. Let's see how interest rates impact consumers and take a look at smart ways to decrease/avoid interest if you find yourself in a bit over your head with credit card debt. For this section, we are going to look at the payment calculator in the Savings Calculator tab.
Credit Card Rates
Credit card interest rates are highly variable and can range from 0% to 25%+ depending on the individual's credit score and the type of credit card. For this example, the tables shown below are for a 12% interest rate, which is relatively low for credit cards, and a 22% interest rate. The tables do not show a 0% interest rate, because that is equivalent to paying in cash.
The table to the left shows the interest charged on a $50,000 credit card balance in one year, based on a12% interest rate. $6,000 (based on a $50,000 balance) would be charged annually until the full balance was paid off.
The high, 22% interest, credit card results in even more cost, as $11,000 is interest is charged to the borrower in the same scenario. Keep in mind that if the balance is not paid off, the interest will continue to accrue, resulting in more and more charges.
Although interest is expensive, credit cards can be great financial instruments if used responsibly (paid off every month). They allow an individual to build credit prior to making large purchases such as a car or home. Being that you can pay off a credit card once a month, it is also allows financial flexibility, leaving more cash in the bank account that can grow interest, until paying off the credit card in full.
Credit Card Troubles
A majority of people that I know, including myself, have gotten themselves into some sort of credit card trouble and had to dig their way out. As we can see above, carrying hefty credit card balances can be detrimentally expensive. There are a few ways to avoid this, but I found a couple of things that helped me.
Get a 0% (balance transfer) interest credit card
Transfer your credit card balances to the interest-free card
Stop saving and put all extra money into paying down the new card
Stop using your credit cards and only use cash for goods need (which means no more online shopping. If you do, pay the credit card used immediately)
Pay down credit card with savings
Thanks for reading!
The Complete Financial Workbook: https://www.thefinancecompass.com/downloads
Interest Rates: https://www.investopedia.com/terms/i/interestrate.asp
Savings Account Rates: https://www.nerdwallet.com/best/banking/savings-rates
Balance Transfer Credit Cards: https://www.nerdwallet.com/balance-transfer-credit-cards