Why Do Interest Rates Rise?

If you’ve bought a car, purchased a home, used a credit card, or got a school loan, you probably know what an interest rate is. Basically it’s the cost of borrowing money. The higher the interest rate, the higher the payments you will make on the things you borrow money for.

Interest rate levels are constantly changing and can alter the course of an economy. In fact, over the past 40 years, interest rates have been as high as 20 percent and as low as a quarter of one percent. But the question is what causes them to rise and fall?

In a free banking system—like we have in the United States—interest rate levels are a direct result of the supply and demand of bank loans, or credit.

Although supply and demand naturally drive interest rates, the Federal Reserve is able to affect them as well.

The Federal Reserve, an independent government body, can influence the available supply of credit and thus interest rates by changing the rate they charge banks to borrow money.

Interest rates can impact a wide variety of economic elements—they can be lowered to try and jump start a faltering economy and lifted to curb inflation. When it comes to you and your family, those interest rates can be the difference between buying a house or renting an apartment, or a used car versus a new car.