Factors that Determine Interest Rates

An interest rate is the rate at which borrower of money takes money from lender of the money. Interest is calculated as a percentage of the principal balance taken by the borrower of the money. Interest rates never remain same they keep on changing so why it changes well the answer to it is that interest rate depend on many factors, let’s look at some of the factors which determine the rate of interest –

1. The first and foremost factor which affect the interest rate is the demand and supply of money, if the demand for money is higher than supply than it will lead to increase in interest while if demand is lower than supply of money then it will lead to decrease in interest rates.

2. Another factor which influences the rate of interest is the rate of inflation, if inflation is high then government increases the interest rates for borrowing in order to contain the inflation.

3. Interest rate is also dependent on the growth rate of the economy, so if the economy is strong then government tend to keep interest rate high while if the economy is in recession or growing at lower rate than interest rate is kept low so that economy can grow at faster pace.

Apart from above factors interest rate at which loan is given to an individual is determined by several factors like creditworthiness of the individual, nature of security given for taking the loan, source of income of the individual who is taking the loan etc…..

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