Interest Rates On Loans

Interest ratesFixed Rate Interest

Fixed rate interest is exactly as its name suggests – interest fixed throughout the period of the loan.  The advantage of having a fixed rate interest is that it is easy to calculate the exact figure you need to repay.  Your budgeting can then reflect this.  The downside is that there is usually a breakage fee (cost of funds) if you want to repay the loan early.

Floating Rate Interest

Floating rate interest can work in a number of ways. Usually, however, you’ll see this described as being: Base Rate plus basis points.  Although the basis points (which is a percentage figure) are fixed, Base Rate is a floating rate set by the Bank of England from time-to-time; hence the overall interest rate floats.  The upside to a floating rate interest is that there is rarely a breakage fee – if you make early repayment.  The downside is that the rate can swing very quickly against you – as happened in the early 1990s when the Bank of England was raising Base Rate almost weekly.

The best way to try to calculate whether to use fixed rate interest or floating rate interest is to ask the lender to do an Annual Percentage Rate (APR) calculation for you.  APR calculations are adjusters, and so this should help you to determine the real rate of annual interest you’ll need to pay on the loan.

THINGS TO THINK ABOUT

Finally, here are some things to think about if you’re considering a loan:

  1. is it absolutely necessary for you to fund the purchase through a loan.  Sometimes dipping into your saving will mean you save in the end;
  2. look around for the cheapest (cost) loan;
  3. when looking at interest rates, always ask an APR calculation;
  4. make sure you fully understand the security issue;
  5. don’t agree to any add-ons, like insurance, unless you believe you’ll need them;
  6. if you’re going to need to fund the purchase for a period over one year, a loan will nearly always be cheaper than other forms of short-term debt financing – like a credit cards;
  7. don’t sign any loan agreement unless you’re completely satisfied you understand what’s being asked of you.  All too often, we are in a hurry to buy the product and don’t read the small print.  Remember, “buy in haste, resent at leisure.”