What is an interest rate?
The interest rate is the cost of borrowing money, which is determined by how much you pay for your loan in relation to the amount of money you borrow. Interest is the form of payment to the lender or borrower required by law to be paid on a loan. It is usually expressed as a percentage of the principal amount borrowed. Interest rates vary according to the type of loan, term, and actual or anticipated cash flows. For instance in case of provident funds the conditions of interest would vary and you would have to use a pf interest rate calculator to find out how much interest you are earning. However, for a student loan the conditions would be different and you’ll have to use a different calculator.
Interest may also be charged on credit cards and other consumer credit products, but this is usually at much higher rates than loans. Interest is generally calculated from the beginning of one billing cycle to the end of another. The most common types are listed below:
- Fixed Interest Rate
Fixed interest rate is the interest rate that remains fixed for a specified period of time. For example, if you take a loan at 10% and repay it in 3 years, your lender may ask you to repay with an annual interest of 10% only, meaning that you will pay back 100*0.10=10 every year. There are two types of fixed interest rates: fixed for one term or fixed for multiple terms.
- Variable Interest Rate
Variable interest rate is the interest rate that may change with time and currency exchange rates. The higher the risk of losing money from this type of loan, the higher the monthly payment will be. This type of loan has many benefits such as no prepayment penalty but also has some downsides such as high fees and high chance of bankruptcy caused by variable payments! If compared to fixed interest rate, fixed-rate loans are generally cheaper than variable-rate loans because they don’t change throughout their term; however, fixed-rate loans tend to carry higher interest rates than variable-rate loans because they carry less risk and therefore lower default. Undeerstanding how vairable interest rate impacts the principal amount can be difficult to track. This is why you should use an interest calculator online instead of doing manual calculations so that you don’t get shocks when you see bank statements of remaining loan amount.
- Prime Interest Rate
This is an interest rate set by banks for loans made by various commercial lending institutions for short-term unsecured deposits such as corporate debentures and securities issued by municipal governments and state governments in the United States (US). The prime rate is determined daily in New York City by a survey of money market funds and other institutional investors who hold short-term debt instruments issued by banks in New York City’s primary money market trading facility, known as “the money market”.
The prime rate is the highest interest rate offered by banks, credit unions, and other lenders when they lend to businesses, individuals or governments at a time when there are no incentives for them to do so. It’s often used as a benchmark for comparing rates across different institutions. That is also how it gets its name “prime rate” because it’s used as a reference point by banks when setting rates for other loans with longer maturities and/or smaller amounts borrowed.
Hence it is extremely useful when comparing different loans with varying terms and lengths.
- Simple Interest
This is the simplest type of interest. It is also called nominal interest and is expressed as a percent in decimal form. For example, if you borrow 100 for one year at 10% annual interest, then you will receive 10 for every 1 you lend. In other words, you will receive your principal back plus an additional 10 per year for 12 months.
- Compound Interest
Compound interest is the result of the simple interest rate being compounded over time. For example, if you have a 10% annual compound rate on your investment, then each time your principal increases by 1000 it will grow by 11% (i.e., 1 + 0.101 = 1.11). This means that if you have 100 invested at 10%, after one year you will have 110 (100*1.11) invested at 11%.
