2.3b Interest Rates

Interest Rates

Interest is:

The cost of borrowing money.

The reward of saving money.

Interest is expressed as a percentage.

The Bank of England sets the UK Base Rate based on the performance of the economy. Lenders set their own rates based on this

Borrowing Money

A business will often borrow money to finance their activities (e.g., purchasing stock, expansion)
Consumers will borrow money in the form of loans, overdrafts, or mortgages
The amount borrowed must be repaid plus interest
The higher the interest rate percentage, the more which must be repaid

Saving Money

When a business has money in the bank, the bank will reward the business by paying interest on the savings
Consumers may have bank accounts which pay interest as a percentage of the amount saved
This can be an additional income

Effects of Interest Rates on Business

Low Interest Rates

Cheaper to borrow money
Less interest earnt on saved money
Businesses may have more money to spend on other parts of the business
They may take advantage of low interest rates to borrow more money to grow / improve the business

High Interest Rates

More expensive to borrow money
More interest earnt on saved money
Demand for products and services decreases
Higher repayment costs, coupled with reduced sales, may mean companies struggle to pay staff which can lead to an increase in unemployment

Effects of Interest Rates on Consumers

Low Interest Rates

Lower repayment amounts on loans, especially mortgages
Less interest earnt on saved money
Consumers have more money to spend
Demand for products and services increases

High Interest Rates

Higher repayments on loans, leaving less money to spend on everything else
Reduced spending on products and services
More interest earnt on saved money

Simple Overview

This is a very over-simplified overview:

High interest rates = less spending

Low interest rates = more spending