How Interest Rates Work

Interest rates are perhaps the most important to consideration when selecting a loan or saving account. As such, banks have a variety of interest rates for their various accounts and loans. You should always check the interest rates carefully, along with the other terms and conditions of the loans and accounts.

Understanding must first begin by noting that interest rates are always quoted as a percentage figure. For loans this percentage figure is how much interest will appreciate on the loan total, meaning that the higher the loan is the more interest you will have to repay on top of the original loan figure. With savings accounts the interest is appreciated on your own saving total, and so this is interest that the bank is repaying you with. As such, the more you have saved in a saving account the better.

It is a legal requirement that banks quote interest rates as an annual percentage rate (APR). As such, this figure highlights what the interest rate will be for the whole year, and also takes into account compound interest. Compound interest is accumulated on top of the original interest. As such, if you open a saving account it is usually the case that the interest is returned once annually. Although, a few saving accounts may provide interest on a more monthly basis.

There are really two types of interest rates: variable and fixed. Variable interest rates are more prevalent, and with these the interest rate may not always remain the same as when you opened the account. The rates that these are set at largely depend on the economy, and in the UK a base rate that is set by the Bank of England. As such, your saving account variable interest rate will likely go up and down.

The other alternative interest rate is that of fixed interest rates. Fixed interest rates are those that are set at a fixed rate by the bank or account provider. As such, these fixed interest rates will always remain as they were when you opened the account. Usually, fixed interest rate accounts provide a slightly higher than average rate of interest for a more specific time period. They usually require a minimum investment amount, and that you do not withdraw anything from them until the account closing date when the interest is added. However, these saving accounts can vary somewhat.

Bonus interest rates are also another thing to look out. What is a bonus interest rate? Well really, bonus interest rates are a short term higher interest rate, usually for the first year an account is opened. These can be higher than average interest rates, but after the bonus rate period the interest will then likely drop to a lower interest rate hereafter. So, it’s worth checking what this lower rate of interest will be if you are looking for longer term saving account options.

Another thing to note is that interest rates for saving accounts can also be progressively larger depending on either how long you save for, or how much you invest in the account. A saving account may offer higher and lower rates of interest for various investment levels. The higher investment levels will therefore have higher interest rates.

As such, saving accounts and loans can come in various packages with a variety of interest rates offers. If you are borrowing you should make sure that you can meet the loan and its interest rate. Alternatively, if you are saving you should note whether the account is easy access or not, and if not that you can save for the period required.