Things you will know after reading this article:
- What is rate of interest?
- Six major types of interests
- What is base rate?
- How do rates of interest vary?
- Interest on savings account
Simply put, Interest rates determine the amount paid by borrowers (debtors) for holding money from lenders. These rates are usually expressed as a percentage of an amount paid for a period of one year, however, they are also sometimes calculated over shorter periods. Offered interest rates vary from product to product and from bank to bank, with a number of factors contributing to the rate of interest. In other words, The total interest on an amount lent or borrowed depends on the principal sum, the interest rate, the compounding frequency, and the length of time over which it is lent, deposited or borrowed.
Rate of interest are of various forms, depending upon the bank or the organisation.
There are six major types of interests:
- Fixed interest-
This is quite self-explanatory, it’s a specific, fixed interest tied to a loan or a line of credit that must be repaid, along with the principal. A fixed rate is the most common form of interest for consumers, as they are easy to calculate, easy to understand, and stable – both the borrower and the lender know exactly what interest rate obligations are tied to a loan or sum borrowed.
- Variable interest-
Interest rates can fluctuate, and here the rate of interest is tied to an ongoing “base-interest” provided by the bank. In this case, the borrower may benefit when the base rate declines, but they may also have to pay more when it rises. Base rate is specific and set by the Reserve Bank of India, and no bank is allowed to lend below the assigned rate. The base rate drops during an economic crisis.
- APR (Annual Percentage Rate)-
Here the total interest is expressed annually on the total cost of the loan. This very common in the credit card companies.
- Prime Rate-
Prime rate is provided to few favoured customers of the bank, it is usually lower than the usual rate of interest. However, prime rates are applicable in very few loans.
- Simple Interest-
This is a quick and easy method of calculating the interest for any some of money for any variable period of time provided. It is determined by multiplying the daily interest rate by the principal by the number of days that elapse between payments.
- Compound Interest-
In compound interest, the interest on the loan is calculated annually. It is interest calculated on the initial principal, which also includes all of the accumulated interest from previous periods on a deposit or loan.
How do rates of interest vary?
Now we have the basic idea about the types of rate of interests that are available. These rates of interest are variable, and are different for each loan. Let us discuss a few-
- The credit score plays a major rale in the calculation of the rate of interest. Credit is the is the total amount of money a person or business can borrow from a bank or other financial institution. A borrower’s bank credit depends on their ability to repay any loans and the total amount of credit available to lend by the banking institution. The borrower with a higher score gets lower interest rate.
- The rate of interest is lower when the tenor for loan is short term. It is in the favour of the borrower to keep the tenor short, as the risk of being unable to repay the amount decreases, and so does the rate of interest.
- It is in the best interest of the borrower if the loan is secured, or a collateral loan. A secured loan is where the borrower provides a financial asset as a collateral to the lender in case they don’t pay back the loan.
- Rate of interest also depends upon the past conducts in the account, the history of repayment of the borrower.
Interest rates in savings account-
Your money saved in an account is never stagnant, it is ever growing. When you deposit money in an account, the bank provides you with a rate of interest upon your money in the account. The interest rate is calculated by the end of the day to the nearest rupee. The current rate of interests provided commonly by the banks ranges from 2.5% to 3.5%. This varies from bank to bank.
The summary of the entire discussion is that loans which make it easy for us to achieve our goals and dreams, take care of our responsibilities do come with an extra price to pay, but with smart planning like short term and high credit loans, all of the above discussed pointers we can learn how to maximise our benefits and use the funds to its maximum potential.