The Basics of Interest (Part Two)
Fixed and Variable Rates
There are two types of interest rates applied to loans. It is important to know which type of interest rate is being applied to your loan. Most banks offer a variety of interest bearing accounts. Most of these accounts have fixed rates, a set rate for the life of the account. An example would be the common savings account that has a set interest rate. These are normally low rates. Another example would be a CD. These are mostly fixed rate investments. You would get a three-year CD with a 7 percent interest rate and that rate will stay the same until the three years are up. Whatever option you choose you should understand the kind of interest rate you are getting when you open the account.
Alongside knowing the type of interest rate you getting on your investment, you should also be aware of the type of interest rate you will be paying on your loan. This information must be shared with you before you enter into the loan agreement therefore you should definitely ask your bank representative for this information before any commitment. Of course the key for banks to make money is to keep the interest rates as high as they can while still being competitive.
Credit cards, auto loans, personal loans, home equity loans, and mortgages are all usually fixed rate loans, however some credit card lenders, and home loans may have variable rates at which point you should get the details on what causes the rate to fluctuate and how much it will increase.
Lenders can be very slick when it comes to interest rates and their increase because the higher they are the more money for them. One strategy that is commonly used is the low “introductory” offer they use to get your attention. This is where they promise an outrageously low interest rate for the beginning of the loan but then astronomically rising the rate once you enter into the agreement. If you are unsure of all of the details of the loan or feel uncomfortable with the terms don’t sign anything until it has all been explained to you.
I’ll touch a little bit on compounding interest here however for more information on how compounding interest works feel free to take a look at “The Basics of Interest (Part Three)”. Compound interest can work for you or against you. When investing it is a good thing to have an investment that compounds, adds interest on top of interest, on a regular basis. However, if you choose to use your credit card all the time and are only paying the minimum balance, you are dealing with compound interest and it is working against you. What a lot of people don’t realize is that you may have been able to purchase that product at a sale price with your credit card but the interest you will paying on that one purchase will be double and sometimes triple to the original amount you paid.
That’s why it’s important to take a careful look at the terms of your account and never charge anything on your credit card that you will not be able to pay off in full when the balance becomes due. This way you are not paying a high price later for a cheap price in the present.
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