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Transport your imagination into your future: You have been eyeing a new car for several months, and the time is right to buy it. But you don't have the cash to hand to the dealer. What should you do? Most people don't have the cash to pay in full for "big ticket" items such as cars and houses, so they borrow the money and pay it back, a little each month.
The amount of money you borrow is called "principal." The cost the bank charges you to borrow it is called "interest." Interest is usually expressed as a percentage. For example, you might borrow an amount of money at 5% interest. That means that when you are finished paying back your loan, you will have paid the bank the amount you borrowed, the principal, plus interest.
If you are borrowing money, you want to shop around for the lowest interest rate. How do banks determine what interest rate they will charge? Part of the answer depends on the borrower. Do you have a job that will enable you to pay back the loan on time? Is your credit good? Have you paid other loans on time? If the bank thinks it is too risky to loan you money, it may not make the loan at all! That's why it's important to get into good spending and saving habits, even at a young age.
There's another factor that helps determine what interest rate you will pay when you get your loan: the Federal Reserve. "The Fed," as it is sometimes called, is the Central Bank of the United States. The Fed's most important role is to keep the U.S. economy healthy. One way it does this is to set the discount rate. That's the interest rate it charges banks to borrow money. The banks then loan this money to consumers like you. So when the Fed raises or lowers the discount rate, it affects the interest rate you will pay. Now that you're an educated consumer, you can finish your daydream with the purchase of your new car!
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