When making the decision to borrow through the various lending channels, be it a conventional lending institution, credit unions, or individual/private lenders, one of the most important aspects to managing your loan facility would be to understand the loan’s interest rate and how it works.
Whether it’s a credit card, car loan, student loan, or mortgage, the loan interest rate can make a huge impact on the overall repayment cost and, ultimately, the loan repayment period.
We all need cash for various reasons, including emergencies. However, your needs should not be a blinding factor when it comes to choosing the ideal loan. Understanding loan interest rates will allow you to calculate the cost of your debt as well as the repayment period.
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Determining the amount of interest charged on a loan will motivate you into seeking better loan terms elsewhere, one that you’ll manage to pay without too much strain. With that in mind, below is a quick guide to loan interest rates.
1. Defining Loan Interest Rates
When borrowing money, the higher the interest rate, the higher the cost of the loan amount. Loan interest rates can better be described as the cost charged by a lender for borrowing money. Among the personal factors that can affect the interest rate charged by a lender on a loan include one’s creditworthiness and the type of loan needed. Especially for mortgages and car finance, it also depends on whether or not you’ll need some money upfront to qualify for the loan.
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All, the same, understanding how interest is applied to your loan or calculated and how it affects the overall cost is the most important thing. And that, ladies and gentlemen, is the sole intent for this article.
Among the key points to understand when applying for any type of loan is that your interest amount is dependent on the terms of the loan, represents the total amount of the loan, it’s pegged to your bank’s loan interest terms and that the interest rates are bound to rise due to factors such as late payment or defaults.
2. Types of Interest Rates
Now, there are various forms of interest rates, each impacting consumers in a different way depending on the total amount borrowed. One thing to also note is that not all interest rates will be calculated equally. It’s therefore important to ignore the hype on the loan adverts you see floating around in your media devices and instead, conduct your research by personally visiting the lender and digging deeper. Nonetheless, here are some common types of interest rates:
- Compound interest rate – Usually, the compound interest is calculated on an annual basis. Here, the key components of the loan – principal and interest – are used to calculate the total amount of a year’s interest.
- Fixed interest rate – As the term suggests, this is a stable rate affecting consumers and is set to ensure that consumers understand exactly how much they are to pay as well as understanding the loan repayment and other obligations. It’s a fixed interest rate amount that is tied up to a line of credit with the inclusion of the principal amount.
- Variable interest rate – As earlier mentioned, interest rates are bound to rise and fall. These fluctuations affect the interest rate and thus the term variable interest rates.
- Amortized interest rate – Amortized interest rates are common in home and car loans where consumers are allowed to pay a large amount of the interest rate but a smaller amount of the principle. With each monthly payment, the interest amount stays the same, but the principle shrinks with time.
- Prime interest rate – This is the interest amount that most commercial lenders charge to their most creditworthy and most favored customers. The prime interest rate is tied up with the Federal Reserve’s lending capacity.
The takeaway is that whether you’re an investor or just any other consumer looking for a better loan deal, understanding the different types of interest rates will be equally important to maximizing your investment opportunities as well as your consumption.
3. Factors That Affect the Interest Rate
While your credit history may determine how much a lender charges you as the interest rate, there are other factors affecting the interest rate. Some of these factors are out of your control while others are in your control. Below are factors that are out of your control and affect the interest rates:
- Federal rates
- Supply and demand
Factors within your control include:
- Your credit history and creditworthiness
- Loan amount
- Loan duration
- Loan guarantee/collateral
Today, interest rates are playing a huge role in the global economic system. They are affecting how consumers borrow and how much ROI an investment can gain over time. One thing to note however is that a few points can make a huge difference in the overall loan amount and understanding the interest rates can impact your investment decisions.