Interest rates apply to all forms of debt and most forms of saving and earning, yet they rarely come up in conversations about budgeting and financial freedom. Interest rates are closely connected to how much you will pay for a service, how high your debt burden will be, and how much you will be able to save over an extended period of time. That’s why it is essential to have a strong and confident understanding of what interest rates are, how they work, and how they apply to your own personal finances. Here is everything you need to know to make interest rates work for you.
Interest Rates in a Nutshell
Put simply, interest rates are often how much it costs to borrow money. If you’re taking a loan from a bank, they will typically charge interest rates, which are usually a percentage of that loan amount (i.e. 4% of the loan). These rates are both a kind of service fee charged by the bank for giving you the loan and a calculation of the risk they are taking on by choosing you as a borrower.
If you have a low credit score, rates will usually be higher. An annual percentage rate (APR) is how much extra you will pay in interest based on a percentage of the loan. Say you borrowed $1000 with an APR of 5%. That means you will be paying back $50 annually in interest fees.
Interest Rates and Debt
Interest rates are a central consideration when it comes to any decisions on acquiring debt. It is not unheard of for some people’s debt to never go down, because everything they are paying back is going towards the interest, rather than paying down the original debt.
That’s why you should always calculate how much you will need to pay back with interest in order to actually bring your debt load down. Avoid exorbitantly high-interest rates and always dedicate as much of your spare income as possible to paying down your debt, as the sooner you pay it off, the less you will pay overall.
Interest Rates and Mortgages
Interest rates are a hugely important factor to consider when choosing a mortgage. Interest rates on mortgages are determined by both the mortgage provider and the central interest rates decided by a national monetary authority, such as the Bank of England in the UK.
The interest rates on a mortgage will largely determine how much money your mortgage will cost, and even a slightly smaller interest rate will save you thousands in the long-run. This is easier to coordinate than you may think, with free broker services such as Trussle allowing you to compare mortgages and see what the most favorable interest rates that you can access are. This way, you will be able to save significant amounts of money and find a mortgage that you can actually afford.
With a proper understanding of interest rates, you will always be in a stronger position before taking on debt. Never hesitate to ask for more detail on interest rates, and always shop around before committing to a loan or mortgage.