Interest is the fee you pay to borrow money. It's also the income you earn for lending it out or keeping it in a savings account. Think of it as the price of using someone else's money for a period of time. This price is expressed as a percentage of the amount borrowed, called the principal.

If you take out a $1,000 loan with a 5% annual interest rate, you'll owe $50 in interest after one year, on top of the original $1,000. On the flip side, if you deposit $1,000 into a savings account with a 2% interest rate, the bank will pay you $20 after a year for letting them use your money.

The interest rate you see advertised by a bank is the nominal interest rate. It’s the straightforward, stated percentage. If a savings account offers a 3% interest rate, that's the nominal rate.

But the nominal rate doesn't tell the whole story. The world has inflation, which is the rate at which the general level of prices for goods and services is rising, and subsequently, purchasing power is falling. This is where the real interest rate comes in.

Imagine you have that savings account with a 3% nominal interest rate. If inflation for the year is 2%, your money's purchasing power only grew by 1%. That's your real interest rate. You earned 3% more money, but everything costs 2% more, so you're only 1% better off in terms of what you can actually buy.

If inflation is higher than your nominal interest rate, you are actually losing purchasing power, even though your bank account balance is growing. For instance, with a 3% interest rate and 4% inflation, your real interest rate is -1%. Your savings can buy less than they could a year ago.

Like the price of anything else, interest rates are heavily influenced by supply and demand. In this case, we're talking about the supply of and demand for credit—money that can be borrowed and lent.

The supply of credit comes from savers. This includes individuals putting money in banks, investors buying bonds, and institutions with cash to lend. When people save more, the supply of money available for lending increases.

The demand for credit comes from borrowers. This includes people taking out mortgages, businesses seeking loans to expand, and governments funding projects. When more people and companies want to borrow, the demand for money increases.

Here's how it plays out:

• High Demand / Low Supply: If many people want to borrow money but not many are saving, lenders can charge higher interest rates. The price of money goes up.
• Low Demand / High Supply: If few people want to borrow but savings are high, lenders must compete for borrowers by offering lower interest rates. The price of money goes down.

Other factors play a role too. A strong economy often boosts demand for loans as businesses and consumers feel confident, pushing rates up. A weaker economy does the opposite. Lenders also charge higher rates for riskier loans to compensate for the greater chance of not being paid back.