Interest Rates Simplified
Lenders will charge individuals a set amount of money each month for borrowing from them, in addition to their loan repayment.
This is referred to as an interest rate and is usually expressed as a percentage.
The interest rate will be charged on the total amount of money being borrowed, and so it has a vast impact on the amount of money individuals pay back.
Determining interest rates starts with the Bank of England, who establishes a base rate, which determines how much it costs large financial institutions to borrow from the government in the UK.
Large financial institutions like banks will use the base rate to determine the amount of interest they should charge to its customers and other finance companies.
For example, if the Bank of England decided to increase the base rate, it means that the cost of borrowing in the UK has increased, which subsequently encourages lenders to raise their interest charges.
Interest rates have been at historically low levels since 2009 but can fluctuate greatly over time and are dependent upon the health of the economy and government policy.
Fixed or variable: What’s the difference?
Interest rates can be either fixed or variable. With a fixed rate, the amount of interest you are charged will stay at a constant level for an agreed period of time. This means that your monthly repayments will not vary over this period.
Having a fixed interest rate may aid budgeting practices, as individuals will know the amount of money that is to be deducted from their account each month.
Furthermore, if the Bank of England’s base rate increases, individuals will not be charged any additional interest.
However, equally if the Bank of England’s base rates decrease, individuals may miss out on being charged less interest, as they are locked in to a fixed rate term.
Therefore, although having a fixed interest rate can be beneficial, there are also disadvantages to this method.
With a variable rate, the amount of interest charged can increase or decrease each month, meaning that your monthly repayments may fluctuate.
This could pose challenges to monthly budgeting and could create problems for individuals if the Bank of England’s base rate increases.
Individuals may however benefit from having a variable interest rate if the base rate decreases.
How can interest rates affect your loan?
Interest rates are particularly significant, as they determine the amount of money individuals will pay back overall.
A high interest rate will result in individuals paying back a larger amount of money. Whereas, a low interest rate means individuals will be required to pay back less.
It is therefore particularly important for individuals to carefully consider their options prior to taking out a loan, to ensure that they locate a suitable deal that they can afford.
What determines the interest rate incurred?
A variety of different factors can impact the amount of interest a lender charges on a loan.
One factor that can affect the interest rate is an individual’s credit score. Lenders will use the credit score to determine whether to lend money or not.
If an individual has a negative credit score, it illustrates to lenders that they may be unable to repay the loan back, which makes them a higher financial risk.
Due to this, the lender may choose not to lend money to the individual or they may increase the interest rate to mitigate some of these risks.
Another factor that can impact the level of interest charged is the type of loan taken out, for example if the loan is secured or unsecured
Unsecured loans can be offered at very low rates, but this is usually only for those individuals with very good credit scores. Rates for customer’s that don’t qualify for the advertised rates can be significantly higher.
Secured loans may offer better rates for customers, particularly those who do not have good credit scores, however they use an individual’s property as security, which gives lenders the legal right to repossess the asset if monthly repayments are not met.
Interest rates are a particularly important factor to consider when taking out any type of loan.
These rates can be affected by numerous factors, and so it is crucial for individuals to carefully consider their borrowing options and determine a suitable course of action for them.