Since the economic recession, it seems that our TV screens have been filled with news about unemployment, the property market, interest rates and inflation. Now, post-referendum, the tabloids are filled with stories about falling interest rates and rising inflation.

But while most of us can get to grips with how figures on job prospects and housing sales affect us, unless you've taken a course in economics, you may struggle to understand how interest and inflation impact upon your life.

Here, at Trusttwo, we have condensed all of this complicated information and broken it down into one easy-to-understand article.

What are interest rates?

In order to understand how interest rates affect you, first you need to know exactly what they are and how they are calculated.

An interest rate refers to the amount charged by a lender when you borrow money. This is typically expressed as a percentage, usually as an annual rate, commonly referred to as APR. When you repay your loan, you will owe the original capital borrowed, plus the additional interest accrued.

For savers, however, an interest rate relates to the amount earned. Essentially, rather than paying an interest rate on savings, your bank will pay you. Again, this interest is usually added yearly, but the amount you earn will change if your account balance fluctuates.

Interest is calculated using the base rate, which is set by the Bank of England. Currently this stands at 0.25%, but is subject to change. If the base rates go up, lenders will likely increase their interest rates and vice versa, which could seriously affect you.

What is inflation?

Inflation is a little more complicated to understand. Essentially, inflation refers to the cost of living, reflecting the price of goods and services.

Inflation can be measured in several ways, but the most frequent terms you'll hear thrown around are Retail Prices Index (RPI) and Consumer Prices Index (CPI). There are several differences between RPI and CPI, with the largest being that the latter also refers to other items, such as council tax, loans and mortgage repayments. Both of these methods assess the price of commonly bought goods and analyse how these change over periods of time.

Similarly to interest rates, inflation is also expressed as a percentage. For example, if the inflation rate stands at 5%, the average price of goods and services will cost 5% more than they did in the previous year.

How does this affect you?

As of August, the Telegraph has reported that inflation is at its highest point in almost a year, with a price increase of 0.6%. As Brexit continues to loom, many forecasts are predicting higher inflation and falling interest rates.

Interest and inflation tend to work together and when one goes up, the other typically falls. Knowing how they work can help you budget by determining when it's best to borrow money, pay back loans and if life is likely to become cheaper or more expensive. But what does this mean for you?

As inflation rises, the cost of living will increase. In real terms, this means your monthly wage won't stretch as far, as the price of your weekly food shop, household items and entertainment costs rise. You may find that your money has to stretch much further than before and it can become harder to meet any loan repayments.

If you find that your monthly budget won't cover your lifestyle, you could consider cutting back, or dipping into any savings. Alternatively, if you find yourself struggling, you could consider a guarantor loan.

In terms of interest, how you'll be affected all depends on whether you're a borrower or a saver. If you have a variable rate mortgage, you may benefit from lower interest rates, as the amount you repay every month could reduce. However, if you have a savings account and are approaching your annual interest payment, the amount your bank pays into your account could be a lot less.

To summarise, interest and inflation rates affect your daily life, from the price of bread and your lifestyle, to your purchase power and savings. Knowing how they affect you means that you can plan for the future and protect your assets.

Image courtesy of iStock.

This article was posted on: 05/10/2016