When borrowing money, the total amount you pay back is determined by the loan interest rate (in addition to any extra fees you may be subject to). Let’s take a closer look at what these interest rates actually are, how they’re determined, and what it means for your finances.
What are loan interest rates?
Loan interest rates are the cost of borrowing money, usually determined as an annual percentage of the total borrowed amount. When repaying your loan, you’ll pay the agreed monthly fee plus interest, meaning that the total sum you pay back will always exceed the original amount borrowed.
How is this expressed?
You’ll often see interest rates advertised as ‘APR’ (standing for annual percentage rate), although this is technically slightly different from the determined interest rate as it also includes any other fees associated with your loan.
How do loan interest rates work?
For a clearer definition of how these interest rates affect your repayments, let’s take a look at an example…
Jerry takes out a 24 month loan of £15,000 with an interest rate of 2.9% APR. This means that he’ll pay a total of £15,451.20 over the course of two years through payments of £643.80 a month, meaning the loan will cost him £451.20 in total.
What is a good interest rate on a loan?
Interest rates can vary drastically depending on your provider, so deciding what constitutes as a good rate very much depends on a range of external factors. Typically, anything between 6-36% is often considered a fair deal, however this can change wildly – some high street payday loan providers can charge well above 100% APR, so it’s always vital to ensure you’ve properly read the small print.
How are interest rates determined?
Interest rates are predominantly decided by two fundamental factors – how much profit the provider wants to make and, perhaps more prominently, how reliable they deem you to be in your repayment ability.
As such, it’s a general rule that the better your credit score, financial status and repayment history, the better interest rates you’ll be offered, as your risk profile is significant lower. The type of loan you’re applying for also plays a significant role, however. Loan types that require the amount to be secured against assets (known as secured loans) typically charge lower interest rates, as they have the added security of collateral in the event of a missed payment.
The term of the loan is also a very influential factor in determining loan interest rates. Short-term loans will generally have lower rates of interest, as a short-term market is generally more predictable than a long-term one (as economical conditions are less likely to significantly change).
When considering taking out a loan, interest rates should always be a primary consideration. Ensure you understand how the rate that you’re offered will affect the total payable amount and always shop around for loan interest rates that work best for you, as these often vary from lender to lender.
The Jolly Good Loans blog is full of helpful financial tips and advice, and remember, if you’re having financial difficulty, there is help available. Head over to the Citizens Advice website or call the free national debt helpline on 0808 808 4000.