How Are Interest Rates Calculated for Loans?
If you’ve never taken out a loan before, then you might be keen to learn how the unique type of rates applied to them are calculated.
The first thing that needs to be understood is that unlike with mortgages (which feature regular interest rates) loans are commonly subjected to APR – or annual percentage rates. These terms differ quite substantially to regular rates, in fact they resemble the types of conditions seen with fixed term mortgages more than anything else.
What is APR?
APR is the term used for a type of rate that is calculated on a yearly basis. Most lenders and finance agencies will apply annual percentage rates to the amounts that they lend to borrowers. An example of such an arrangement can be found below:
If a borrower wanted to receive $20,000 from a lender with a 10% deposit requirement, the final sum that they’d be given would be $18,000.
This $18,000 would then be subjected to APR, which for simplicities’ sake, we will state as being 15%.
If the cash was to be repaid over the course of five years, the first year would be subjected to the 15% rate, with the following years being evaluated and modified depending on the condition of the market.
So, for the first year, the borrower would be expected to make twelve payments out of sixty in total at 15%.
This would work out to be $300 a month for the first twelve months, or +$45 to cater to the additional APR, bringing the monthly total to $345.
Once the year comes to an end, the lender would evaluate the market and reconsider their agreed percentage – and if necessary, propose a new one for the year ahead. To combat this potential for fluctuation, applicants can opt for fixed rate loans instead – which can help to keep costs the same consistently throughout the duration of the repayment, or for a part of it at the very least.