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Interest rates
Interest Rates Explained

Interest rates indicate the price at which you can borrow money through taking out loans.

Simply put, if you borrow a sum of money at a 5% interest rate for a period of years, it will cost you 5% on top of the amount borrowed. Both the interest and the original capital will need to be repaid to the lender within a specified time agreed between you and your lender.

Interest rates on loans are usually quoted annually, but this is not always the case, so be careful to check with your lender.

How do interest rates work?

If you take out a loan of $1,000 at 5% interest, you would have to pay back a total of $1050 at the end one year from the start of the loan.

Interest rates work in exactly the same way when you are saving money instead of borrowing money. When you are saving, you are effectively lending your money to a bank to do with it as it pleases. When you want to withdraw your savings, the bank will have to pay you a savings rate which is effectively the interest rate it pays you for borrowing your money.

Fortunately, the government does not impose any tax on borrowing money; you simply pay back your chosen loan provider or lender what you owe plus interest. However, this is not the case with savings. When you earn money from savings, the interest you earn counts as part of your annual income. This means you are required by law to pay income tax on it.

Annual Percentage Rates

Annual Percentage Rate of charge or APR is a standardized method of calculating the overall equivalent cost of your debt. It includes both the cost of the borrowing and any associated fees that are included. APRs are meant to help you to compare different credit and loan offers accurately.

APRS vary from lender to lender. This is because the APR is based not just on the interest on the loan, but also other charges you have to pay, for instance, any arrangement fee. All lenders are legally required to inform their customers what their APR is before you are presented with an agreement to sign.

To illustrate this confusing point, if the interest rate is 14% per annum, but the quoted APR is 17%, this would be due to additional charges imposed which accounts for the extra 3%. As a borrower, you need to be aware that APR only includes compulsory charges such as arrangement costs and annual fees. It does not take into account any late payment fees or other non-standard costs. If, for example, you take out a loan, most lenders will automatically include payment protection insurance in the quote. This is voluntary, so you can opt out, but remember that its cost isn't included in the APR.


Understanding Typical APR

For an APR to be considered typical, this interest rate must be offered and approved to at least two-thirds of the loan applicants. However, this effectively means that the remaining third of approved applicants will not be offered this typical interest rate.

It is crucial that you understand this to make sure you are offered the interest rate you think you will be given. When taking out any loan, it is safer to ask for the Total Amount Repayable or TAR. This will indicate the exact amount you will have to repay overall.

Choose a fixed interest rate

It is generally a good idea to taking out a fixed rate loan. This provides you with the security of having a set repayment rate for an agreed period of time, which varies depending on the size of the loan. Fixed interest rate loans help to protect you from random rate increases and market fluctuations.

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