A Beginner’s Guide To Understand The Different Types Of Interest Rates On Loans

Confused about loan interest rates? Our beginner's guide explains fixed, variable, and compound interest rates, so you can make informed borrowing decisions.

5 May,2023 11:54 IST 2729
 A Beginner’s Guide To Understand The Different Types Of Interest Rates On Loans

A debt consists of two components – principal and interest. Principal is the actual amount borrowed while interest is additional charge paid to use the principal. It is an income for the lender to provide the debt.

What Is An Interest Rate?

Interest rate is the rate at which the interest will be charged on the principal amount by the lender. There are various types of interest and as a borrower you should be aware of them.

Why Is Interest Charged On Loans?

Borrowers pay the interest because of the availability of additional funds at his disposal. While the borrower has the money, its purchasing power or real value can decrease. To cover up for the decrease in the value, the lender charges an interest.

Types Of Interest Rates

Following are the various types of interest rates –

• Fixed or Flat Interest Rate –

The interest rate is fixed and constant throughout the tenure of the loan. This is the most common type of interest rate charged and the rate is decided mutually among the borrower and the lender. Its calculations are simple and easy. Since the EMI will be fixed, it gives a clear picture to the borrower about his monthly repayment schedule. There is a clear understanding between the lender and the borrower. It avoids any risk of loan getting costly. The disadvantage is that it may be higher than the variable rate of interest currently available in the market.

• Variable Interest Rate –

The rate of interest charged moves up and down with the market or the index called prime or base interest rate. The borrower will have to pay a higher interest if the prime interest rate increases. But there can be a scenario where the prime interest decreases after the loan approval. In such a case, his interest rate will become cheaper than what was initially assigned to him.

• Annual Percentage Rate –

It is the amount of the total interest expressed annually on the total cost of the loan. It is common in credit card companies and credit card mode of payment methodology. Credit card companies apply this method when the credit card users carry forward a sum of their balance instead of paying the full amount.

• Prime Interest Rate –

It is the rate of interest charged by the banks and other lenders from the borrowers who have a good credit history. The rate is generally lower than the usual borrowing rate. It is generally linked to the Federal Reserve interest rate, the rate at which the banks borrow and lend from the Federal Reserve. It is given only to some of the privileged customers.

• Simple Interest Rate –

It is charged on the principal loan amount by the banks and other financial institutions. Its calculation involves the multiplication of principal, rate of interest and the number of months.

• Compound Interest Rate –

It is the addition of the interest to the principal. In other words, it is the interest on interest. It has two key factors, the interest and the principal amount. The new interest will be charged after adding the previous interest to the principal amount.

• Discounted Interest Rate –

It is not generally applicable to the public. It is applicable to the Federal banks to lend money to other financial institutions on a short-term basis. Banks may opt for such loans to cover up their lending capacity, rectify liquidity problems or prevent itself from a crisis.

Conclusion

Interest is charged on a loan to cover up any decline in the value of the principal lent. The borrower pays the interest for the availability of instant funds. There are various interest rates. You should be aware of the types of interests charged so that you may take an informed decision regarding the loan availed.

Whether you need a personal loan, home loan, loan against property, or a business loan, IIFL Finance has you covered. With competitive interest rates, flexible repayment options, and a seamless online application process, IIFL Finance has made the process of availing a loan easier.

Disclaimer: The information contained in this post is for general information purposes only. IIFL Finance Limited (including its associates and affiliates) ("the Company") assumes no liability or responsibility for any errors or omissions in the contents of this post and under no circumstances shall the Company be liable for any damage, loss, injury or disappointment etc. suffered by any reader. All information in this post is provided "as is", with no guarantee of completeness, accuracy, timeliness or of the results etc. obtained from the use of this information, and without warranty of any kind, express or implied, including, but not limited to warranties of performance, merchantability and fitness for a particular purpose. Given the changing nature of laws, rules and regulations, there may be delays, omissions or inaccuracies in the information contained in this post. The information on this post is provided with the understanding that the Company is not herein engaged in rendering legal, accounting, tax, or other professional advice and services. As such, it should not be used as a substitute for consultation with professional accounting, tax, legal or other competent advisers. This post may contain views and opinions which are those of the authors and do not necessarily reflect the official policy or position of any other agency or organization. This post may also contain links to external websites that are not provided or maintained by or in any way affiliated with the Company and the Company does not guarantee the accuracy, relevance, timeliness, or completeness of any information on these external websites. Any/ all (Gold/ Personal/ Business) loan product specifications and information that maybe stated in this post are subject to change from time to time, readers are advised to reach out to the Company for current specifications of the said (Gold/ Personal/ Business) loan.

Most Read

Check the Difference Between 24k and 22k Gold
18 Jun,2024 09:26 IST
67241 Views
Like 8253 8253 Likes
Franking and Stamping: What’s the difference?
14 Aug,2017 03:45 IST
47764 Views
Like 9588 9588 Likes
Why Gold Is Cheaper In Kerala?
15 Feb,2024 09:35 IST
1859 Views
Like 6154 1802 Likes
Personal Loan With Low CIBIL Score
21 Jun,2022 09:38 IST
31149 Views
Like 8575 8575 Likes

Get in Touch

By clicking on Apply Now button on the page, you authorize IIFL & its representatives to inform you about various products, offers and services provided by IIFL through any mode including telephone calls, SMS, letters, whatsapp etc.You confirm that laws in relation to unsolicited communication referred in 'National Do Not Call Registry' as laid down by 'Telecom Regulatory Authority of India' will not be applicable for such information/communication.
I accept the Terms and Conditions