Interest is effectively the price of money: whether it is the price a bank or lender is offering in return for a loan or mortgage, or the price a saver can expect to receive for depositing their money, it is always calculated by the individual institution involved. Staff Writer Hannah Stevenson offers a breakdown of how this is calculated and why borrowers and savers alike should keep a watchful eye on their rate.
Everyone, from young savers through to businesses and individuals looking to buy their own homes, has heard of interest rates. But understanding how they actually work can be confusing, although it’s actually fairly easy to grasp.
Although it differs around the world, in general base interest rates are set by each country or region’s central bank, so for example the Bank of England, or the United States Federal Reserve Bank. This is the rate that they will be lending and borrowing at, and acts as a national minimum. It is determined by many social, economic and political reasons.
This is the minimum interest rate, however, and as such lenders and financial institutions can select to raise this for loans if they wish. However, they are bound by certain restrictions, such as demand, what their competitors are charging and any additional services they can offer- for example, many loans and mortgages charge higher rates of interest for those who have poor credit or unsecure jobs such as zero-hour contracts.
In general, interest rates are calculated yearly, and then divided by the amount of times they are paid out to determine the rate per month or week, dependant on when this is paid out. This allows them to track the base rate and act accordingly, whilst still enabling borrowers to pay back their interest monthly or weekly rather than just every year, which might prove difficult with larger loans such as mortgages and business loans.
For those who want to keep up-to-date with the latest financial institutions and the decisions they are making regarding interest rates, subscribe to Acquisition International Magazine, as well as its sister publication Wealth & Finance International.