How interest works
Interest can be applied to loans you take out, and the savings and investments that you pay into. There are several ‘flavours’ of interest, so let’s focus on how it affects loans for the purposes of keeping this blog simple(ish).
The interest rate on a loan is how much a customer pays to borrow money, and is shown as a percentage of the total loan amount. Having a lower interest rate is better value than having a higher interest rate, on any credit you take out.
Lenders generally have less confidence giving money to people without a proven track record of paying back on time (or at all). People who haven’t got an ‘official’ credit history that shows they’ve been paying their financial commitments on schedule, and in full, (aka those with a low credit score) are usually faced with higher interest loan options than those with proven payment track records (aka higher credit scores). How much you’re borrowing and how long you want to take your loan out for (aka the loan term) can affect the interest rate applied to what you’re borrowing too.
What’s the difference between APR and an interest rate?
A loan’s APR (annual percentage rate) represents the interest rate that you’ll pay on a loan, as well as any other fees the lender chooses to add per year. RewardRate doesn’t charge fees, but some lenders pop them on top of the loan’s interest amount to cover things like overpayment charges and admin costs. Citizens Advice explains APR nicely here.
A simple explanation of interest
Imagine you take out a loan of £2000 over 2 years. If your interest rate is fixed at 39.9%, over that time you can expect to pay back £2,784.89. £2000 repays the amount you borrowed in the first place. The additional £784.89 covers the interest (the cost of taking out this loan).
Why do interest rates vary?
This is where it can get a little confusing. Interest rates can change over the course of your loan.
Some lenders in the UK will give you a loan with a variable interest rate that can go up. This rate can yo-yo depending on market factors and the Bank Of England Bank Rate.
You can work out how much borrowing might cost you using Money Helper’s neat little loan calculator.
What is the Bank Rate?
The Bank of England sets ‘Bank Rate’: the UK’s key interest rate. This is worth knowing because the figure they set affects interest rates across the country (from lenders and building societies). You’ve probably noticed recent news stories swirling around about Bank Rate soaring throughout 2022, and what that means for regular people seeking credit.
Why interest variation matters
Interest rate variation (even if it’s small) can make a pretty massive difference to the amount you’re paying back, especially if you’re borrowing a hefty chunk of money. It’s definitely worth being picky on the details when comparing interest rates, if you’re looking for a loan.
Feeling more confident now?
Do you now feel like you have a firmer grasp of interest and what it means for you financially? Let us know if this has been useful, and what else we can simplify for you in future posts!