The Basics of Interest Rates: How They Affect Loans and Savings

Whether you’re borrowing money for a new home, paying off credit card debt or trying to grow your savings, changes in interest rates directly affect your financial decisions.

What Are Interest Rates and Why Do They Matter?

At their core, interest rates represent two things: The cost of borrowing money, like a loan, or the reward for saving it, like a CD or savings account. When you take out a loan, the interest rate determines how much you’ll pay beyond the principal amount over time. When you put money in an interest-bearing account, the interest rate dictates how much the financial institution will pay you for keeping your money deposited.
Central banks, like the Federal Reserve in the U.S., use interest rates as a tool to manage economic growth and inflation. By raising or lowering their benchmark rates, they encourage or discourage borrowing and spending across the economy.

• When rates rise: Borrowing becomes more expensive, businesses and consumers pull back, and inflation slows.
• When rates fall: Borrowing is more affordable, spending increases and the economy can grow — but if demand outpaces supply, inflation may rise.

A Look at Recent Rate Changes

Following the pandemic, inflation surged to the highest levels since 2007. In response, the Federal Reserve raised interest rates aggressively, climbing as high as 5.50% in 2023. As inflation cooled, rates gradually decreased, with the federal funds rate sitting around 4.33% in 2024.
These adjustments illustrate how the Fed attempts to strike a balance: Preventing inflation from getting out of control while also ensuring the economy continues to grow.

How Interest Rates Affect Borrowing

Loans are often the first place consumers feel the impact of interest rate changes as banks can typically respond to changes in these rates fastest. Here’s a few examples of this in action.

1. Variable-Rate Loans

Borrowers with variable-rate products see their payments change when interest rates shift. Common examples include:

• Adjustable-Rate Mortgages (ARMs)
• Home Equity Lines of Credit (HELOCs)
• Personal Lines of Credit (LOCs)
• Credit Cards
  
  As rates increase, monthly payments for these products rise, as well.

2. Fixed-Rate Loans and Refinancing

Even fixed-rate borrowers are affected indirectly. When rates fall, many homeowners refinance their mortgages to lock in lower payments and reduce lifetime interest costs.

Key benefits of taking out a loan, when managed wisely, include:

• Access to larger purchases like a home, car or RV
• Building a positive credit history
• Managing cash flow for planned expenses
• Funding investments or business opportunities
• Accessing emergency financial support
• Potentially lower rates compared to credit cards

How Interest Rates Affect Your Savings Portfolio

Interest rates don’t just impact borrowers — they also determine how much savers earn on their deposits. When rates are high, banks generally offer better returns on deposit products. This makes saving more attractive and helps people grow their money more securely.

Popular interest-bearing savings vehicles include:

• Savings Accounts – Flexible and accessible for short-term needs.
• Certificates of Deposit (CDs) – Fixed terms with higher rates for locking in funds.
• Money Market Accounts – Combining higher yields with limited check-writing privileges. 

Depositing money in these accounts is typically safe and secure, but also protects against loss or theft while earning steady returns. Banks that belong to the Federal Deposit Insurance Corporation insure every deposit account up to $250,000.

Why Interest Rates Matter for Your Financial Planning

Understanding interest rates helps you make smarter decisions about when to borrow, refinance or save. By paying attention to rate trends and aligning them with your goals, you can:

• Lower borrowing costs through refinancing opportunities.
• Take advantage of higher savings rates during rate hikes.
• Better manage your long-term financial strategy.

Working with a trusted financial partner ensures you’re always in the best position to respond to changing interest rates.

OMB and its affiliates do not provide legal, tax or accounting advice. You should consult your legal and/or tax advisors before making any financial decision.