Interest rates are a key factor in almost every formal borrowing and saving transaction, from home mortgages to credit card debt. They are also important for personal financial planning, business budgeting and even the growth of retirement savings accounts. Understanding how to calculate an interest rate will help you make better decisions when it comes to your finances.
In the simplest sense, an interest rate determines the extra amount paid back in addition to the original sum borrowed. This is what allows lenders and banks to earn money on their investments. However, an interest rate can be used to describe a variety of different concepts in finance, from compounding to credit risk. This article will explore the various types of interest rates, including simple interest, compound interest, annual percentage rate (APR) and more.
Simple interest is a straightforward method of calculating interest earned or paid, where the total amount accrued over a period is divided by the initial principal, and then expressed as a percentage. This formula can be used for loans or deposits that have a fixed term, such as a one-year mortgage. For loans or deposits with variable terms, the interest is calculated using an annualized formula, such as APR, which factors in both the interest rate and fees.
There are many factors that influence an interest rate, including the borrower’s creditworthiness and economic trends. Different types of loans and savings options also have their own unique interests rates. For example, a secured loan like a mortgage will have lower interest rates than unsecured loans like credit cards.
