Unsure about interest rates?
How do interest rates work?
The concept of interest underpins many different aspects of economics and finance. As an ordinary person, you’d be forgiven for not being completely clued up on what it all means and how it can impact your life.
Fortunately, this guide gives you all the information needed to understand interest rates better. Below, we explore what they are, why they’re important and, crucially, how they can impact you when borrowing money.
What are interest rates?
An interest rate is essentially the cost of borrowing money. Most people borrowing from a lender will be charged interest. If you’ve taken out a loan or credit agreement, the interest rate is the percentage of the money borrowed that you have to pay back in addition to the original loan amount and any fees.
You can also earn interest through savings and investments. For example, when you have cash stored in savings accounts, the banks or institutions holding your money effectively borrow it from you and therefore pay you an interest rate on the amount you have saved.
There are various types of interest rates and many different levels of interest set by different organisations – this is where it all gets a little more confusing. We explain this more in the next section.
What are the different types of interest rates?
When you hear or read the term ‘interest rate’, this may mean one of a few different things. It could be referring to:
- The Bank Rate: Also referred to as the ‘base rate’, this is set by the Bank of England in the UK. The Bank Rate is the single most important interest rate in the UK – if it rises, all other interest rates are likely to follow and vice versa.
- The interest rate charged by lenders: Banks, building societies and other lenders can set their own interest rates on mortgages, credit cards and other types of loan agreements. These are partly determined by the Bank Rate but also by other factors such as the level of risk being taken on by the lender or the lender’s own cost of borrowing. To compare interest rates on unsecured products you need to look at the ‘APR’, while secured lending products, such as mortgages, use ‘APRC’ (more on this below).
- The interest rate offered on savings: Just as banks and building societies set the interest rates for their loans, they also set interest rates for their savings accounts. The Bank Rate is influential again, as is the type of savings account or product. Savings interest rates are usually advertised as ‘AER’ (Annual Equivalent Rate).
Why are interest rates important?
Interest rates are important for you, the individual, as well as the wider economy. A higher Bank Rate set by the Bank of England means you’ll pay more to borrow money but can earn more for saving it.
This is often done to encourage people to spend less and save more to curb rising prices and inflation. In a healthy economic climate, lower interest rates help to encourage spending by minimising the cost of borrowing.
If you already have a mortgage or another loan agreement, or you’re taking one on soon, a change in interest rates can directly impact you. You could be left paying more or less, depending on whether the rate rises or falls and if you’ve got a fixed or variable agreement with your lender.
What are interest rates on loans?
Interest is charged on most types of loans, whether it’s a mortgage, secured loan, debt consolidation loan or an unsecured personal loan. The interest rate is the percentage of the money borrowed that you have to pay back on top of the original loan amount.
These rates are usually advertised by lenders as an ‘APR’ (Annual Percentage Rate) for unsecured loans or ‘APRC’ (Annual Percentage Rate of Change) for secured loans. Both figures consider the fundamental interest rate of the loan combined with any additional charges. ‘APRC’ often gives you a more comprehensive look at secured loan agreements such as mortgages, particularly if you’re on a variable interest rate.
Fixed vs variable interest rates on loans
Interest rates on loans can be either fixed or variable. One isn’t necessarily better than the other but both can have pros and cons.
Fixed rates may be offered for an introductory term (such as with mortgages) or the full term of a loan (more common with personal loans). While fixed, these rates are unaffected by external factors such as Bank Rate changes, making it easier to budget your repayments. You won’t face higher repayments if rates increase during the fixed period, but you won’t benefit if rates come down either.
Variable interest rates can change during the term of your loan. While there is a chance you could owe more if rates increase, you could also see your repayments decrease if the interest rate falls. All our loans here at Evolution Money come with variable interest rates.
What factors determine the interest rate on a loan?
The interest rate offered by a lender depends on a few factors and your individual circumstances. Generally speaking, the greater the risk they’re taking on, the higher the interest rate they’ll charge. The factors most commonly considered include:
- The amount you’re borrowing
- Your chosen loan term
- The type of loan you’re taking out
- Your credit score and history
- Your deposit (for mortgages)
- The value of any assets you’re using as security (for secured loans)
How can I get lower interest rates on a loan?
Lenders ultimately have the final say on the interest rates they offer but there are ways in which you can give yourself a better chance of securing lower rates.
The main one is to improve your credit score. This can be done by ensuring all your financial information is accurate, making payments on time and showing you’re trustworthy with credit. Paying off other debts can also help to make you less risky as a borrower.
It’s always worth adjusting the amount you’re looking to borrow and the loan term to see how it influences the interest rate you’re offered too.
Consider a secured loan from Evolution Money
If you’re looking to make some home improvements, consolidate your debts or get a loan for any other reason, consider borrowing from Evolution Money. We offer secured loans for homeowners up to £100,000, with flexible loan terms from 3 to 20 years. Check your eligibility with our online form today.
We are regulated by the Financial Conduct Authority and we’re proud members of the Finance and Leasing Association so you can apply with confidence. Check out our customer reviews to see why we’re rated ‘Excellent’ on feefo.
For a typical loan of £30,000.00 over 120 months with a variable interest rate of 19.56% per annum, your monthly repayments would be £598.34.
Including a Product Fee of £2,400.00 (8% of the loan amount) and a Lending Fee of £807.00, the total amount repayable is £71,800.20.
Annual Interest Rates ranging from 11.88% to 29.38% (variable). Maximum 50.00% APRC. The loan must be paid back by your 70th birthday. Read more.
Think carefully before securing debts against your home may be repossessed if you do not keep up repayments on your mortgage or any other loan secured against it. If you are thinking of consolidating existing borrowing, you should be aware that you may be extending the terms of the debt and increasing the total amount you repay.
