What Are Interest Rates?
A comprehensive guide to understanding interest rates, their types, and their impact on the economy
What Are Interest Rates?
Interest rates are a fee or price you pay when you borrow money, or a reward you earn when saving money. They are calculated as a percentage of the amount borrowed or saved.
Example: Borrowing Money
If you borrow 500,000 PKR from a bank in Pakistan and the interest rate is 17.5%, you will have to return 587,500 PKR after one year. That extra 87,500 is the interest—the bank’s fee for lending you the money.
Example: Saving Money
If you save 20,000 PKR in a bank and take it out after 4 months, the bank will pay you extra money (based on the interest rate) as a reward for letting them use your money during that time.
How Do Banks Make Money?
Banks don’t just store money—they make money too! Here’s how:
- Charging interest on loans people and businesses take
- Investing in government bonds, the stock market, and local businesses
- Fees and services like ATM charges, account maintenance, etc.
Types of Interest
Fixed Interest
This interest rate stays the same from start to finish.
Example: If you borrow at 5% fixed interest, you’ll pay exactly that—no matter what happens in the market.
Floating Interest
This interest rate can go up or down, depending on market changes.
It’s affected by inflation—the general rise in the prices of goods and services.
Why Are Interest Rates Important?
1. Controlling Inflation
When inflation is high, things become expensive and people can’t buy as much. To fix this, the State Bank of Pakistan can increase interest rates, which:
- Makes borrowing more expensive
- Reduces business and consumer spending
- Lowers demand, which helps bring prices down
2. Managing Unemployment
When companies aren’t hiring, unemployment rises. To help, the bank can lower interest rates, which:
- Makes it easier for businesses to borrow money
- Encourages investment in new projects
- Creates more job opportunities
Conclusion
Interest rates may seem like just numbers, but they’re actually powerful tools. They help keep the economy stable, control inflation, and manage employment. Whether you’re borrowing or saving, understanding interest rates helps you make smart money choices.