Interest rates are a fundamental aspect of our financial lives, and understanding them is important for making decisions about taking out loans, investing in assets or building savings. But the concept can seem complex, and different types of rates—like variable versus fixed—come with their own benefits and risks.

The most basic definition of interest is a payment made to a lender for the use of borrowed money or assets, typically expressed as a percentage of the principal. This is how lenders earn income from lending out their funds, and it helps keep the economy running smoothly by rewarding individuals and businesses for spending or saving.

Various factors help determine interest rates, including supply and demand for money, inflation, market conditions and monetary policy set by the Federal Reserve. High interest rates make borrowing more expensive, which can slow economic activity. Low interest rates, on the other hand, can stimulate the economy by encouraging consumers and businesses to spend or invest more.

Whether you choose a variable or fixed rate, it’s important to understand how the rate is determined before signing up for a new loan or credit card. For example, a credit card may advertise a 4% interest rate, but the true annual percentage rate (APR) factors in inflation and bank fees for a more accurate picture of how much you actually pay or earn. A similar calculation is also used for mortgages, which takes the total debt and amortization schedule into account.