Interest rates can apply to anything from your savings to your mortgage, personal loan and many others. We’re going to delve into the ins and outs of interest rates and help you secure the most competitive for all your loans and savings accounts.
Understanding interest rates is critical in not only accessing competitive financial products but, in making sure that you boost returns on savings.
Interest rates can be confusing at times but, it’s all basic math at the end of the day and you can learn all you need to know. Understanding interest rates can offer you numerous benefits that will help you consistently make savvy decisions with your money.
What exactly is an interest rate?
Let’s use interest rates charged on credit cards as an example. An interest rate is a set figure which a lender will charge you in return for offering you use of a set credit limit.
This interest rate will be applied to any outstanding balance as a percentage. It is used to essentially make a profit on the total amount you have used and for their services.
You must pay, at the very least, the minimum repayment every month, or your outstanding debt will continue to grow. It's of paramount importance that you know what your interest rate is, and how it affects your loan and your total repayment.
The better your credit - the better your interest rate
If there is a lower chance that the client in question will stick to the repayment terms, the bank charges a higher interest rate to ensure that it receives increased returns for the higher risk. Generally, banks are quite competitive with interest rates but, these vary from client to client, and circumstances, of course, play a part in any transaction.
For the aforementioned reason, generally, credit cards and revolving loans will be issued with a higher interest rate. It’s all about risk versus reward. The higher your credit score, the lower your interest rate will be, as your bank will trust that you will have all your repayments made on time and in full.
So that’s all there is to interest rates?
Not exactly, as there are different types as well. These are fixed and variable rates. Fixed rates are will never change through the term of the loan, and variable rates, such as those charged on mortgages, change based on the prime rate as set by the Reserve Bank.
When it comes to mortgages, in the earlier term of the loan, you’ll be paying a higher percentage of your monthly interest amount. As time passes and you continue to pay your monthly installment, a greater percentage of the loan principal will be paid off.
Mortgages that have fixed rates will retain a fixed interest rate for a set period after which they will revert to a variable interest rate.
Variable rates work just a little differently. They change along with the prime rate, and when this prime rate rises, so do your payments in turn. It’s always best to pay attention to what the prime rate is so that you're never caught out by nasty hikes.
You can even make extra payments, with both types of interest rates but more so with variable interest rate loans.
Another rate you need to be familiar with
The next rate to consider is your APR, which stands for annual percentage rate, and governs many aspects of lending. This rate includes and encompasses brokerage fees and closing costs. The bank begins with the actual interest rate and then adds “points” onto it, which are once-off fees.
The APR will give you an exact idea of the overall cost of the loan. Sounds simple right? Generally, it is, and understanding your APR will help you get the most out of your loan.
You can also use your APR to determine the cost of a loan and compare different loans, to ensure that you get the best deal you can when acquiring finance. Comparing loans with APR needs to be done uniformly. Comparison rates are also used to compare loan options but, is not as popular as APRs.
When comparing, say, a loan with only interest to one with lower interest and added fees, at some point, they will both have cost the same amount of money.
You can use this point to work out which loan suits you in the long run, which will cost you more over a certain amount of time, and which loan is a better option for your pocket.
Comparing loans can be enormously beneficial to any new borrowers or credit card holders who need the best loan deal they can get.
What else do interest rates affect?
Lots of things, of course! One is the economy, and this is a powerful effect at that. For example, at the epicentre of banking in the United States of America, we find the Federal Reserve Bank. This is America’s central bank, and as with the central bank in any country, it sets the interest rates for banks across the country.
The Federal Reserve Bank sets the fed funds rate as the benchmark. All other banks across America set their interest rates according to this when it comes to matters such as overnight loans and quick-approval loans.
The rate affects a vast variety of things to do with the country’s economy, including the financial health, economic strength and money supply. Should the most experienced professionals not be dealing with this matter, things would surely fall into ruin on a wide scale.
As a knock-on effect, if the interest rate is too high, this means many businesses and individuals will be unable to afford loans, which means that the economy will suffer as the flow of money will be stopped dead in its tracks. This, in turn, slows the credit available to people and this slows consumption. This is hugely detrimental to a country’s well-being.
What about low interest rates?
Obviously, on the opposite end of things, a low-interest rate can create huge market booms and encourages consumer spending, meaning the flow of money changing hands will have a drastic boost.
Businesses can afford to take out business loans, the average man or woman on the street can now afford to take out loans for personal use, and the economy of the county is strengthened.
Investors might see the drop in an interest rate as a chance to dive into that risky investment they’ve been eyeing out, with the possibility of earning massive profit. This, in turn, drives stock prices up, and thus provides even more benefits.
So why not keep them low all the time?
This is a widely asked question with a very simple answer: Inflation. Low-interest rates can flood a country’s market with loads of currency, and this decreases its value, meaning that that currency as a whole will lose its power on the global market. It’s a balancing act to keep a country strong and its currency powerful, viable and useful.
What can I do with this information?
Now that you have a basic idea of how interest rates work, it’s time to go out into the world and see what you can do to benefit from them.
Remember to weigh up all your options and do all the necessary calculations to ensure you get the best deal. Use every resource you have to make safe, beneficial decisions that will lead to sustained financial growth.