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What are an Interest Rate, its Definition, Kinds, and Key Points?

April 27, 2017 Financial No Comments Email Email

When the conversation turns to banking, the interest rate is the foundation of the relationship between bank and customer. The companies with the best interest rates have more customers and win the market.

However, there is a strong need to know and define the interest rate. The further information will help you to compare interest rates of the banks and realize which one will satisfy your interests the most.

The interest rate is a percentage related to the principal (an amount of money you lend to bank when you place a deposit or bank lends to you). So, the rate is an amount of money you or your bank pay for using the debt. In order to be profitable banks charge borrowers bigger interest rates than they pay depositors.

How does it work?

This rate is applied to the unpaid amount of the loan or the balance of your credit card. It is always important to know it and how much it adds to your overall debt. Otherwise, you may have your debt increasing even if you are making payments.

The main point is that the interest rates depend on different factors and may vary throughout a single bank. For example, they are higher for the risky clients.  The difficulty of the loan also affects the rate. It means that if it takes a borrower more time and efforts to pay the loan, the more interest rate will expect him. That’s why it is important to know and improve your credit score (the feature of a person or a company that reflects their solvency).

What interest rates can you find?

They are determined according to the kind of the loan. Usually, the interest rates are divided into fixed (the percentage is not changing during the period you or your bank are in debt) and variable.

The most common rate is APR (annual percentage rate). This is the best option for comparing the price for different borrowing options. It can include all fees the bank may charge you.

What can affect an interest rate?

The overall amount of interest may differ from its initial rates. There is a method which allows you to calculate the final sum of the interest. It is called EAR (effective annual rate). It is usually applied to the interests that compound several times per year. In other words, it is a real amount of money you get or need to pay depending on the fees and inflation.

There are many reasons that make interests change. The aim of the bank or creditor is to protect the interest from inflation, as it causes the same amount of money in percentage to have lower purchasing ability in the future. Inflation rates are the main option for determining the profitability of the loan.

The second thing that can affect the interest rate is the cost of capital. It is a complicated rate that measures the virtual profits the bank could have had with the alternative investment or debt. That’s why smaller banks usually got higher interest rates than big ones.

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