In simple terms, a Loan interest Rate is a charge which a bank imposes on certain loan amount given for a particular period of time .
The Interest rate is that charged amount, which claims to as a percentage of the principal, determined by a lender to a borrower for the utilization of financial assets.
Financial Institution/Bank calculates rate of interest on an annual basis, referred to as the annual percentage rate (APR). For example- suppose A bank lends 10000 Usd to customer at rate 10% per annum, so the annaul interest will be 100 USD per annum.
The assets borrowed could include cash, commodity , and enormous assets like a vehicle or building.
The history of interest rate
From the start of our civilization from 3000 BC lender has been charging a loan rate of interest on borrowers.
From time to time the rate of interest changes from lower to higher.
It means there are several rate of interest changes between short-term rates and long-term rates have happened from 3000BC to till now.
The Different Types of interest rate
There are tons of various sorts of loan rate of interest which is calculated at the time of the given loan, So let’s discuss that sorts of rate of interest
Simple Interest Rate
it’s rate which is calculated by multiplying a principle amount with S.I rate and it’s tenure,Formula interest = Principle×Rate×tenure
For example If Principle amount is 1000,Interest rate 10% and Tenure is 2 years then interest is 1000×10%×2 =200 It means interest for two years are going to be 200
How to calculate EMI/Installment per month using simple interest rate formula ?
Suppose an individual wants to require Loan Of 1000$ @10% Interest Rate for tenure of 24 month So EMI are going to be –
The Installment per month is $50
Normally interest rate use in Study Loan and Automobile loan available with source investopedia.com
Compounding rate of interest
Compounding interest is calculated on accumulated principle with interest with a specified rate of interest and tenure.
Compound interest rate is the interest on interest process to find out the Monthly Installments
Compounding Interest applys in some cases when the borrower fails to pay the loan installment with
in certain period.
For example- suppoose a bank lends money to Mr.A $1000 US dollar to repay it with in 5 year @10% Per annum But Mr. A unfortunately could not pay the annual instalment for first 3 consecutive years.
How much he has to pay the compound interest for 3 years, Let’s see
First year, 1000 × 10% = 100(1st year Interest)
Second year, 1100× 10% =110(2nd year Interest)
Third year, 1210×10% =121(3rd year Interest)
At the last, Mr.A will pay the compound interest $331 US dollar at the end of 3 years. So It’s better
always to pay the Installment at right time.
On the other hand Compound interest can be best option for the borrower, If you want to know how
let me show you an example
Suppose same person Mr.A has already lent $1000 US dollar from the Bank but repays consecutively for 3 years then the calculation would be
First year, 1000×10%=100
Second year, 900×10%=90
Third Year, 810×10%=81
So, Mr.A will pay $271 US dollar compound interest to the bank after 3 year of
Compound interest are often understood by multiplying the initial principal amount by one plus the annual rate of interest raised to the amount of compound periods minus one. the entire initial amount of the loan is then subtracted from the resulting value.
The formula for calculating Compounding rate of interest
Compound Interest = Total amount of Principal and Interest in future (or Future Value) less Principal amount at the present (or Present Value)
= [P (1 + i)n] – P
= P [(1 + i)n – 1]
Let’s say Principle(p)-50000, i-10% or 0.10,n-1 year,If we calculate interest = [50000(1+ 0.10)^1] -50000
=5000(C.I. for 1 year)
If we calculate interest for two Years and Interest is compounded Monthly then Formula would be = A = P(1+r/n)(nt)
Let’s say Here P=50000,R=10% or 0.10,n=12 & t=2 year So Total interest after 2 year are going to be
Hence,Compound Interest are going to be (60950-50000) =10950 for two year
Fixed rate of interest
Fixed rate of interest is a hard and fast rate either at the top of it’s given tenure or Partly period as per decision made between lender and borrower.
Generally this sort of rate of interest may be a favorable for borrower because rate of interest doesn’t change during tenure period thanks to economic effect.
sorts of loan provided in Fixed rate of interest
Banks and financial organization also are providing Fixed rate of interest Loan like
- short-term real estate loan
- auto loan
- federal student loan
- personal loan
Variable or Floating rate of interest
Variable or floating rate of interest is an rate of interest which impose on Loan amount differently from time to time or It’s rate of interest fluctuate either increase or decrease during a period of your time thanks to reference rate .
Here,Variable or floating rate of interest offers same sort of loan like consumer loan ,auto loan,mortgage loan and student loan as like in fixed rate of interest But the difference is variable rate of interest is lower as like fixed rate of interest
Prime rate of interest
Prime rate is additionally referred to as prime lending rate and it’s a interest type, which a bank provides loans on special customers means a customer must be creditworthy for a bank .
The following loans which lends in Prime rate of interest
small commercial loan
It is the speed where bank provides loan on minimum hike of rate of interest and Prime lending rate cannot exceed interest rate but it’s rate is generally but other interest rate
More over it completly depend upon bank that which type loan interest rate they can charge on their customer.
If you are taking loan in future, take a loan on compunding method because it can save you a lot more money for you.
If you’ve got any query please comment below because i will be able to also attempt to clarify your doubt…