If you're applying for any type of finance, whether it's a secured or unsecured loan, credit card or a mortgage, there's a lot of confusing terminology to get your head around. From repayment terms to credit scores, it's vital you understand the most important aspects.
However, one of the most difficult to understand can be interest rates. Although they’re a constant across all types of borrowing, interest rates are very rarely consistent. They can change massively depending on what type of product you’re applying for, as well as your personal circumstances.
To understand what interest rates are, how your lender decides what interest rate to charge on your borrowing and what this means for your repayment terms, we’ve put together this helpful guide to rates and how they impact your borrowing.
What are interest rates?
Interest rates are essentially the fee you pay to borrow money, regardless of the product, which is paid back over the duration of your borrowing period. They enable the lender to make money when they give you a loan, credit card or any other type of finance. Interest rates are calculated as a percentage of the total value of your borrowing and are paid back as part of your repayment plan, increasing the total value of what you owe.
Whenever you borrow money, you’ll see the interest rate you’re being charged indicated as a percentage. This is usually presented as an annual percentage rate (APR), which shows the percentage of the loan value you will be charged by your lender on a yearly basis.
Interest rates differ depending on the type of borrowing you’re applying for too. For example, if you take out a personal loan, your interest is calculated against its total value. However, for other types of finance such as credit cards, the interest you pay will be worked out against the balance of your account at the time of your monthly statements. Therefore it can differ depending on how much you owe.
Repayments and interest rates
The biggest factor interest rates affect is your repayment schedule. When you borrow money, it’s not as simple as splitting the amount you owe into equal amounts over the agreed repayment term. Your lender will charge interest on how much you owe, which will increase the monthly amount you have to pay in total.
Before applying for a loan, it’s worth checking the interest rate charged and how that will affect your total repayments. It’s important to consider whether you can afford to repay the money, as well as the interest owed on the borrowing.
Another consideration is whether or not your interest levels are a fixed rate. If they are fixed with the lender, then your repayments will remain the same throughout the duration of your loan, allowing you to budget for what you owe and providing consistency to your borrowing.
However, if the rates are variable, then your repayments may go up if the base rate rises. It’s worth considering what impact this could have and making sure you can still afford repayments in the event your interest rates change.
What affects your interest rate?
Interest rates are dependent on a number of different factors, some that are personal to you and others which are economical. For example, the base interest rate, set by the Bank of England, impacts what lenders charge. Put simply, when the base rate rises, so too does the cost of borrowing.
On a personal level, your circumstances will determine how much interest you pay on loans and other forms of borrowing. Your credit rating is the primary factor here, but there are also other things to consider, including your:
- Current earnings
- Employment status
- Existing levels of debt
All of these things are carefully considered by lenders, who will weigh up how much of a risk lending to you represents. If you are in unstable employment, have a bad track record of borrowing or a low credit score, you will be viewed as a higher risk. It’s then likely you’ll be offered a higher rate of interest when borrowing to compensate for this
How can I get a lower interest rate?
The lowest and most favourable rates of interest are typically reserved for those who have a strong credit score, so to get better interest rates when you borrow, the most important thing is to ensure you improve your credit score. This won’t be an overnight project, but it’s something you can work on to build up over time, improving your chances of getting a better rate of interest.
To improve your credit score, you can take a number of measures. A few simple steps include:
- Ensuring your address and personal details are up to date
- Always making payments on your existing debts in a timely manner
- Keeping your total debt low in comparison to the credit limit you have (on credit cards, for example)
It’s also possible to find more favourable rates of interest without having to wait. The best way to do this is to shop around for the best deal. While it’s true that your personal circumstances are the main factor in deciding your interest rates, some lenders will offer more favourable terms than others, so it can pay to take time to find the best deal for you. This can often be done through a broker, who will seek out the products that best meet your needs.
Find out more about interest rates and discover the best loan products for your needs with Norton Finance.