What an interest rate is can sometimes be a little difficult to get into, as it can cover several different elements. There are different types of interest rates, depending on what agreement you have entered into with your loan provider, and you also get interest if you deposit money into the bank.
Therefore, here we will give you an overview of the different types of interest rates.
Here’s how to understand the concept of interest
The interest rate is the calculated percentage rate of a fee or income associated with deposits and lending of money.
An interest rate can be seen as either what you have to pay to borrow money, or get paid to put money into the bank. The interest rate applies to both deposits and loans.
If you have to borrow money from the bank, they will most often charge a fee in the form of the interest rate to lend you a given amount. The interest rate is most often determined by the type of loan, the size of the loan you want to take out and how long you want to repay over.
In the case of deposits with the bank, where you deposit money into a savings account, the bank will give you interest on your money, which should be seen as motivation for saving. However, the interest rate on deposits is relatively low at present, due to the global economic situation. Therefore, you will not get as much in deposit rates as you would have received earlier.
Two types of interest rates – Fixed and variable
When talking about interest rates, there are two different kinds – the fixed interest rate and the variable interest rate.
The variable interest rate follows the market rate determined by Danmarks Nationalbank, which follows the interest rate of the European Central Bank. With a variable interest rate, there will be a tendency for greater uncertainty about the interest rate on your own loan.
One of the benefits of having a variable interest rate is that if the interest rate falls, your monthly expense on the loan will also decrease. The downside, however, is if interest rates rise, your spending will increase each month, which can ultimately strain your finances.
The fixed interest rate, on the other hand, is a safer choice. Here, the interest rate is determined from the day the loan is taken out, and you will not have to pay more than what was initially agreed. That way, the interest fee on your loan will neither increase nor decrease during the period you repay the loan. One disadvantage of the fixed interest rate is that you will most often have to pay an interest rate that is higher than the market rate. This is because a higher collateral is provided in the fixed-rate loan. At the same time, the fixed interest rate is also a big advantage as you always know what you will have to pay back on your loan.
Factors that determine your interest rate
Even if you try to apply for a loan in different banks, they can each offer you different interest rates. The bank assesses factors such as your income, fixed expenses, availability amount, age and level of education to determine what interest rate your loan should have.
Income – This factor has the greatest impact on your interest rate level. If you have a high income, you also get a better credit rating as the bank is more likely to get their money back again.
Fixed expenses – To be able to borrow money from the bank, it will always be necessary to present a budget of your fixed expenses every month.
Available Amount – Your monthly available amount is the money you have left after paying all your fixed expenses. If you have a high amount of money available, you will receive a lower interest rate, as the bank is again more likely to get their money back if there is a surplus in your finances.
Age and education level – If you are young, it usually means that you will receive a higher interest rate. Young people do not have the same pay conditions as the slightly older ones, and they are also often less able to meet their payment obligations. Therefore, the bank runs a higher risk by borrowing young money, which is reflected in the interest rate on loans. If you have a reasonable level of education where there is security for good wages and unemployment is low, this will positively affect your interest rate as you will probably find it easier to find a new job in case you lose your job and the wise repay the loan as agreed.
The greater the risk the bank must take in accordance with these factors, the higher the interest rate.