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Bree Sterne:

Interest rates influence borrowing costs. They can affect the cost of home, car, and business loans. They can even affect how much interest a credit card company charges, what the U.S. government pays to borrow money, and more.

The story of interest rates here in the U.S. begins with our central bank, called the Federal Reserve, or the Fed. The Fed sets a key interest rate — the federal funds rate. It raises and lowers this rate to pursue its dual mandate of price stability and maximum employment.

Broadly speaking, higher rates make borrowing more expensive and can help cool an overheating economy. Lower rates do the opposite, stimulating economic growth.

Let's take a closer look at what happens when the Fed raises interest rates. This is known as tightening monetary policy. In doing so, often the Fed's goal is to raise rates just enough to control inflation without strangling the economy.

When the Fed increases the federal funds rate — that is, the interest rate that banks charge each other for overnight loans—it can become more expensive for banks to borrow money. To compensate, they may raise interest rates for mortgages and car loans.

As a result, families may face higher monthly payments or delay buying a home or a new car. A higher federal funds rate can also push up the prime rate. Credit card companies use the prime rate to determine annual percentage rates, or what interest you pay on a credit card balance.

Those who do not pay their bill in full may find they need to charge less on their credit card or pay more in interest.

Companies often apply for a bank loan to fund the growth of their businesses. A higher interest rate often means a more expensive loan. As a result, the company may choose to borrow less or rein in expansion plans. It may experience slower growth and lay off workers to protect profits.

In a worst-case scenario, a company may even go out of business if it relied too heavily on debt. If higher rates negatively affect enough companies, investors may lose confidence, and financial markets may suffer.

Higher interest rates can also mean higher borrowing costs for the U.S. government. This can push up the national debt and increase the budget deficit.

But the Fed isn't always raising rates. Sometimes, it lowers them. This is known as easy monetary policy, and it does the opposite of what happens when the Fed hikes rates. It makes borrowing less expensive.

Credit card interest rates can drop. So can the rates for car loans and mortgages. This encourages spending and investment and overall economic growth, and often rising prices.

But if prices rise too fast, well, we've already discussed Fed tightening. The point is, a small change in the federal funds rate can affect other interest rates and cause ripple effects throughout the economy.

To recap, interest rates influence the cost of borrowing. This can affect the cost of buying a home or a car, credit card interest payments, and business and national debt payments.

Keeping an eye on interest rates, especially when the Fed is making notable moves, is critical when evaluating the investment landscape and making important financial decisions.

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