Interest rates play a huge role in the way we borrow money. They affect the cost of our mortgages, credit cards and auto loans. We pay them for borrowing money but also earn them on the dollars we save in our bank accounts and certificates of deposit (CDs). Understanding how they work is critical to making savvy financial decisions that align with our life goals.

Interest is a percentage of the amount borrowed or deposited that is paid to the lender or investor over a period of time, typically a year. There are different kinds of interests, such as nominal and real, that reflect how the principle is calculated.

There are also different types of debt, such as secured and unsecured, which can influence the interest rate. For example, a mortgage loan is typically secured by the home, allowing lenders to sell the property to reduce their losses if the borrower stops paying the debt. This can lower the interest rate charged.

Another factor that influences the interest rate is the current economy and monetary policy. When demand for credit is high and supply low, interest rates typically rise. Conversely, when the economy is strong and monetary policy is loose, interest rates usually fall. Choosing between a fixed and variable interest rate can be a big decision, but both have pros and cons depending on your situation. Fortunately, most lenders let you change your loan terms from one type to the other if necessary, but there are often fees associated with this.