Types of Interests Rates and How They Work

Most people don’t know about all of the different interest rates that exist, but it is very important to learn about this before getting a loan. It can help you make the right decision to save as much money as possible in the future. The interest rate that you get on your loans and credit cards will have a huge impact on your ability to repay your debt. This is just one of the reasons why you need to understand these things.

Simple Interest

First we will take a look at simple interest or nominal interest. This type of interest rate is based on the original amount of the loan you get. It is very straightforward and not complicated in the slightest. For example, if you borrow £1,000 at a 10% interest rate, you will have to pay back £1,100 (not including any other fees).

Compound Interest

Compound interest is a bit more involved than simple interest. Where simple interest is just a percentage of a total amount, this type of interest increases continuously over time. If you put your money in a savings account, you will keep earnings more every single year. This can also apply to borrowing though. Many banks use compound interest with money that their customers borrow from them, but this is not always the case.

Fixed Rate vs. Variable Rate

When you get a loan of any kind, you will have either a fixed or variable interest rate. It is crucial that you understand the difference between these two types so that you can choose one that matches your needs. You don’t always get to decide, but a lot of private lenders are extremely flexible.

A fixed interest rate does not change over the course of the loan at all. A variable interest rate starts off at a certain amount and is subject to change after a certain period of time. Many people feel a lot more comfortable with fixed rates because they do not fluctuate at all. It is important to keep in mind that you do have the potential to save money with a variable rate, especially if it goes down. You never know what will happen though, so it is a risk.

The lender can choose to lower or increase a variable interest rate according to many different factors, including the market as a whole. If you improve your credit while you still have the loan, you might be able to convince them to lower your rate.

Annual Percentage Rate

The term annual percentage rate or APR is very common when discussing and learning about loans. It is essentially the number that represents the yearly rate of interest on a loan. It gives potential borrowers a complete idea as to how much their loan is going to cost overall. This number includes upfront fees and other charges that the lender might require you to pay.

It is very important that you find out what the APR is with various lenders before deciding which one to get a loan from. By doing this you will be able to choose the least expensive borrowing option overall. While interest is just one factor to consider, it is very important for many reasons.

Annual Equivalent Rate

The annual equivalent rate or AER is the rate that represents the total amount of interest your money earns in a given year. Everyone needs to have at least a fairly good understanding of what it’s all about, as it will affect your ability to earn money on your savings.

Introductory Rates

When you are looking into some of your credit card options, you will likely notice that some of them come with 0% interest. This is just the introductory rate, which means that it only applies for a specific amount of time. Usually this is about a year, though it depends on the card. A credit card with a 0% introductory rate can be beneficial for a number of reasons. If you are trying to pay off your current debt, you could switch it over to a card with a zero percent rate. You will only have no interest for a limited time, but it is still something to keep in mind.

The more you learn about the different types of interest rates, the better your chances will be of getting the most out of your loans and savings. You might be surprised at all of the negative consequences and missed opportunities you have suffered from by not knowing these things. If you are planning to get a loan anytime soon, you definitely need to focus on your rate. Take the time to get quotes from numerous lenders so you don’t get stuck with an outrageously high rate that will make it difficult to pay back your debt.

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