On the surface, borrowing money seems straightforward: a friend loans you twenty bucks, and you give it back when you get paid. Easy. If only the rules were so simple with banks and credit card companies. However, these types of debt come with interest rates.
Interest rates are often the most confusing part of loans and credit cards. Interest rates can be incredibly complicated, especially when factoring in the influence of the Federal Reserve, international trading, inflation, and a dozen other factors. Understanding the full scope of the financial world can feel like juggling twelve bowling pins and spinning three plates while balancing on a ball, but let’s rip away all these factors and break down the basics behind interest rates.
A good general definition for an interest rate is a charge paid for borrowing money. Banks don’t hand out loans out of the goodness of their hearts: they use their money—or the money of their account holders—to make more money. An interest rate is a way of calculating the fee you will be charged for borrowing.
Loans rarely carry a flat fee. The fee changes depending on the size of the loan and the length of time it takes you to pay the money back. So, the actual interest you pay is a percentage—the rate—of the money left unpaid on your loan, plus some minor fees.
Here’s an easy example: I borrow $500 from a bank. The loan has a 5% interest rate. That means every year, 5% of whatever money is left will be added to the loan. If I don’t make any payments, in a year that $500 will become $525.
Now imagine I paid $200 of the $500 over the course of a year. My rate would remain the same—5%—but the charge would be lower because I’ve paid down the principle. Now what I need to repay is only $315.
This is a very basic description of interest rates. There are also variable rates, rates that accrue over a certain period of time, and interest rates that actually earn you money such as on a savings account. And interest rates on home loans are even more complex. But for basic cards and loans, this understanding will serve you well.
It’s also worth noting that the rate you’re given for a card or loan is often determined by your credit history and score. The higher your credit score, the lower your interest rates. Americor can help you save thousands of dollars by reducing your rates and payments. If you’re interested in building a more stable financial future through lower interest rates, contact Americor today.