Interest rates are attached to multiple types of things people need to survive. Credit Cards, Loans, and home mortgages all have added financial requirements to acquire funding to help you buy your life’s security. Interest rates are also on the money you lend out to the institution through accounts like savings accounts and certificates of deposit.
Both types of accounts provide the person providing the loan with a certain percentage of interest for the use of the funds for their personal needs. There are different kinds of accounts, and not all are calculated the same, and not all are compounded at the same rate.
What is Interest?
Interest is attached to any amount of money borrowed. Interest is a predefined percentage amount added to the principal amount borrowed. If you lend someone money, it is the principal, which means they have to pay back with the costs of the borrowed money, along with interest.
If you borrow the money, you will need to pay back the original amount plus the amount of interest that compounded daily, monthly, or yearly. Your loan will have the exact terms defined.
Different Types of Interest
There are different types of interest, and the type of loan and the lender will determine what you which type you get. There are good things about each type of interest. Applied in different situations to people and calculations for determining borrowing, saving, and investing, this guide will show you each one.
- Simple Interest
Simple interest is the most basic type of interest rate. A simple interest rate is only a onetime payment that does not change. You can figure out what type of interest rate you will get by multiplying the principal amount of money by the rate and the length of the term.
- Compound Interest
A compound rate will charge interest on the principal amount of the loan account and any interest that was previously earned. The interest rates are on savings accounts and credit cards.
- Amortized Rates
Amortized rates are used on home loans and car loans. These are applied to small amounts of principal and larger amounts of interest. The way amortized rates are calculated applies the largest amount to the interest getting added to the amounts of money being paid onto the original loan amount. As the principal amount shrinks over time, the interest rate charged on it will shrink as well. The interest rate will not change over time, and the principal reduced.
- Fixed Interest Rate
A fixed interest rate is one that does not change over time. A fixed-rate is on many long-term loans and mortgages. These rates will not fluctuate, which means the rate and amount you pay will not change over the length of time of the loan. It makes it easy to maintain a budget as the rate won’t change, and the payment will stay the same the entire time you have the loan.
- Variable Interest Rates
A variable interest rate will change depending on the index value of the day. Variable interest rates are adjustable-rate mortgages and other types of loans where the rate does not stay fixed. The rates change weekly and monthly, depending on the things the bank needs. The change of rate can make it hard to maintain a budget over time because the rates on loan will increase or decrease for each monthly payment. It can also mean lower payments when interest rates are down.
- Prime Rates
Commercial lenders use prime rates for select types of customers. Banks daily set the Federal Funds Rate as they lend and borrow funds from other banks. Large corporations are the ones that receive prime rate loans. Prime rates are used for larger projects, which is why most of these are for large corporations. The average consumer can get these are well for use in mortgages, personal projects, and small business loans.
- Discounted Rates
Short-term loans made by the Federal Reserve Bank get discounted rates depending on the projected cash flows, the value of the money, and the future risk applied to the account.
- Nominal interest Rate
Nominal interest rates are monetary price borrowers are required to pay to lenders when they use the money. It is the percentage the borrower will pay on top of the amount borrowed.
- Real interest Rate
The real interest rate takes inflation into account when it applies to the principal amount. The rate will give investors an accurate way of determining buying power, the nominal yield, and the nominal yield when making a financial decision.
- Effective Interest Rate
An effective Interest rate is the concept of compounding. It takes into account the percentage of rate compounded annually and semiannually. It is a way to determine that amount of investment for the future. The formula will mathematically show the investor how much they will make for the duration of the loan and the periods compounded.
- Annual Percent Rate
The annual percentage rate (APR) is the yearly amount that is applied to every loan and investment. These are the ones compounded every year on the same date.
- APY (Annual percent Yield)
The annual percentage yield is the amount earned every year when the investment is compounded. It is a normalized interest rate compounded every year.
Having an understanding of interest rates is a way to know how these rates affect your life. They are in all types of financial situations. They are on the home and car you buy; they are on the credit card you carry and attached to those student loans you can’t get rid of.
The next time you plan a large investment or purchase, you can figure out what you will be paying over time and know what the financial terminology means. Being informed is a way to be responsible for your financial decisions. It means being in control of your money and future.