In short: An interest rate is the price of borrowing money, and the return for lending it. Central banks set a key short-term rate, and that influences what banks charge and pay. Longer-term rates also reflect expected inflation, growth and risk, which is why your mortgage rate does not move in lockstep with the central bank.
What an interest rate pays for
A lender charges interest for three main reasons: giving up the use of the money for a time, losing buying power to inflation, and accepting the risk of not being repaid. Add those up and you have roughly what a loan should cost. That explains why a credit card, which is unsecured and risky, charges far more than a government bond. The Federal Reserve reported an average rate of 22.36% on credit card accounts assessed interest in the third quarter of 2026.
Where rates come from
The chain starts with the central bank. In the United States, the Federal Open Market Committee sets a target range for the federal funds rate, the rate at which banks lend reserves to one another overnight. In October 2026, it held that range at 3.75% to 4%. As Federal Reserve Education explains, changes in that rate move other interest rates, which shape financial conditions, household and business spending, and ultimately employment and prices.
| Rate | Influenced most by | What moves it |
|---|---|---|
| Savings accounts | Central bank rate | Bank competition and funding needs |
| Credit cards | Prime rate, tied to the fed funds rate | Your credit risk and the card’s terms |
| Auto and personal loans | Short- to medium-term rates | Credit score, loan term |
| 30-year mortgages | Long-term bond yields | Inflation expectations, growth, investor demand |
| Government bonds | Markets | Expected policy, inflation, supply of debt |
Why long rates behave differently
The central bank directly influences short-term rates. Longer-term rates are set in the bond market, and they reflect what investors expect short rates to do over many years, plus compensation for inflation and uncertainty. If investors think inflation will stay high, long rates can rise even as the central bank cuts. This helps explain why mortgage rates sometimes rise right after a rate cut, which confuses many homebuyers.
The difference between short and long yields is called the yield curve. Normally, longer loans pay more. When short rates exceed long rates, the curve is said to be inverted, which has often preceded US recessions, though it is an imperfect signal.
Real rates versus nominal rates
The headline figure is the nominal rate. The real rate, roughly the nominal rate minus inflation, is what actually matters for your buying power. A savings account paying 4% when inflation is 3.7%, the 12-month figure the Bureau of Labor Statistics reported for September 2026, earns about 0.3% in real terms by simple subtraction. A loan at 5% during 10% inflation would be cheap in real terms, since you repay in far cheaper dollars.
Real rates also affect the economy. Low real rates encourage borrowing and spending, while high real rates cool them down.
Why central banks move rates
Central banks adjust rates to balance economic objectives. The Federal Reserve has what is known as a dual mandate: maximum employment and price stability, with inflation averaging 2% over time. When inflation is high, it tends to raise rates to slow demand. When the economy is weakening, it tends to cut them. Our guide on what the Fed does sets out this process.
The effects are spread out and slow. Mortgages and loans reprice at different speeds, and spending decisions take time to adjust. That lag is why central bankers rely heavily on forecasts and sometimes overshoot. Higher rates aimed at inflation can also trigger a recession if taken too far.
How rate changes reach you
A rise in rates has several direct effects. Borrowers with variable-rate debt, such as most credit cards, soon pay more. New fixed-rate loans cost more, although existing ones stay the same. Savers eventually earn more, though banks often pass increases along slowly. Bond prices fall when rates rise, since existing bonds pay less than new ones. Stocks can come under pressure as well, as future profits are worth less when discounted at a higher rate.
Rate cuts generally work the other way. Housing is especially sensitive, a link we cover in why houses are so expensive. All this forms part of our broader explanation of how the economy works.
Frequently asked questions
Why doesn’t my savings rate rise as fast as my card rate?
Banks tend to pass on rate increases to borrowers faster than to savers, particularly if they have plenty of deposits. This gap helps their margins. Online banks often pay more because they have lower costs and need to attract deposits, so it can pay to compare rates, rather than leave money in a low-paying account.
Who decides mortgage rates?
No single body sets them. Lenders price mortgages largely in relation to long-term bond yields, plus a margin for costs and risk. The Federal Reserve influences those yields indirectly through its policy and expectations about the future. Your own credit score, down payment and loan type then determine the rate you are offered.
What is the prime rate?
It is a benchmark that banks use to price many loans, including credit cards. In the US, it usually moves closely with the federal funds rate, traditionally sitting about three percentage points above it. Your card’s rate is often quoted as prime plus a margin that reflects your credit risk.
Can interest rates be negative?
They can. Some central banks in Europe and Japan set negative policy rates in the years after the 2008 crisis, in effect charging banks to hold reserves. Real rates can also be negative when inflation exceeds the interest rate. Banks generally avoided passing negative rates on to ordinary depositors, however, for fear of withdrawals.
