How Interest Rates Work:
A Simple Guide for Everyday Canadians
Whether you’re borrowing money or saving it, interest rates play a big role in your financial life. They can either cost you more—or help your money grow.
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We’ll break down what interest rates are, how they work, and how to make them work for you (not against you). Just the basics you need to know.
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What Is an Interest Rate?
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An interest rate is the price of money—either the cost to borrow it or the reward for saving it.
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Borrowing? You pay interest.
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Saving or investing? You earn interest.
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It’s usually shown as a yearly percentage: the annual interest rate.
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Two Types of Interest
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Simple Interest
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Earned only on your original amount (called the principal).
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Example:
$1,000 at 5% for 3 years → $150 earned
Total = $1,150
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Compound Interest
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Earned on the principal and the interest already earned. This is where real growth (or pain) happens.
Example:
$1,000 at 5% for 3 years (compounded yearly) → $1,157.63
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You earned more than $150 because the base grew each year.
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This is why compound interest is often called the eighth wonder of the world.
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Why Interest Rates Matter
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Interest rates affect:
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Credit cards
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Mortgages
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Student loans
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Savings accounts
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Investments
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A 1–2% difference may seem small—but over time, it can add up to thousands.
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How They Impact Saving vs. Borrowing
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Higher rates are bad when you owe (debt grows faster).
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Higher rates are great when you save (money grows faster).
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Example:
Saving $10,000 at 1% for 10 years = ~$11,050
Saving $10,000 at 5% = ~$16,288
That’s a $5,000+ difference.
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Who Sets Rates in Canada?
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The Bank of Canada sets the overnight rate, which influences the prime rate banks use to price:
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Mortgages
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Credit cards
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Loans
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When rates go up, borrowing costs more.
When they go down, borrowing is cheaper.
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Why Do Rates Change?
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The Bank of Canada adjusts rates to guide the economy:
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If inflation is high → raise rates to slow spending
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If growth is weak → lower rates to encourage borrowing
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Think of it like a thermostat: dial up or down to stabilize conditions.
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Fixed vs. Variable Rates
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Fixed rate = stays the same → good for stability
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Variable rate = changes with the market → riskier, but might save money
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Know what you’re signing up for.
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Make Interest Rates Work For You
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If you’re borrowing:
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Shop for the lowest rate
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Pay off high-interest debt fast
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Use fixed rates for predictability
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Avoid compounding interest on loans if possible
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If you’re saving or investing:
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Choose accounts with high interest
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Start early—compound interest rewards time
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Understand how often interest is added (monthly? annually?)
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Quick Trick: The Rule of 72
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A simple formula to see how long your money will take to double:
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72 ÷ Interest Rate = Years to Double
At 6% → 72 ÷ 6 = 12 years
At 8% → 72 ÷ 8 = 9 years
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Final Thoughts
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Interest can build your wealth or bury it. The difference is how you use it.
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Borrow wisely
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Save early
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Pay attention to rates
The more you understand interest, the more power you have over your financial future.