Lenders will charge a set amount of money each month for borrowing from them, in addition to the loan repayment. This is called an interest rate and is usually expressed as a percentage.
The interest rate will be charged on the total amount of money being borrowed, so it has a big impact on the overall balance that is repaid.
Determining interest rates starts with the Bank of England, which establishes a base rate. This determines how much it costs financial institutions to borrow from the government.
Financial institutions, like banks, will use the base rate to determine how much interest they should charge to their 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 risen. As a result of this, lenders may raise their interest charges.
Interest rates have been at historically low levels since 2009 but can fluctuate greatly over time.
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. This means that your monthly repayments will not vary over this period.
Having a fixed interest rate may aid budgeting practices, as you will know the amount of money that is to be deducted from your account each month.
Also, if the Bank of England’s base rate increases, you will not be charged any additional interest.
However, equally, if the Bank of England’s base rates decrease, you may miss out on being charged less interest, as you will be locked into 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 rise or fall each month, meaning that your monthly repayments may fluctuate.
This could pose challenges to monthly budgeting and could create problems if the Bank of England’s base rate rises. However, you may benefit if the base rate falls.
How can interest rates affect your loan?
Interest rates are important, as they determine the amount of money you will pay back overall.
A high interest rate will result in you paying back a larger amount of money. Whereas, a low interest rate means you will be required to pay back less.
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 your credit score. Lenders will use the credit score to determine whether to lend money or not.
If you have a negative credit score, it illustrates to lenders that you may be unable to repay the loan, which makes you a higher financial risk.
Due to this, the lender may choose not to lend money to you 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 low rates, but this is usually only for those with very good credit scores. Rates for customers who don’t qualify for the advertised rates can be much higher.
Secured loans may offer better rates, particularly for those who do not have good credit scores. However, they use your property as security, which gives lenders the legal right to repossess the asset if monthly repayments are not met.
Conclusion
Interest rates are a particularly important factor to consider when taking out any type of loan.
These rates can be affected by numerous factors, so it is crucial for you to carefully consider your borrowing options and determine a suitable course of action.
Think carefully before securing other debts against your home. Your home may be repossessed if you do not keep up repayments on a mortgage or any other debt secured on it.
