bank-credit

There are many types of interest rates. They are classified according to the duration of the borrowing and lending (known as rates in the short, medium or long term), by function (rates of the Central Bank, the bank base rate and so on.) According to their mode of calculation (proportional rate, current yield, percentage rate), depending on whether one takes into account whether or not inflation rate (real or nominal rate). Here is an explanation of the meaning of these different rates and their use .

Simple – Compound

When speaks of simple interest and simple interest rate of a loan, the interest due for a given period are actually paid in the end. For example, when you buy € 10 000 to 7-year bonds yielding a rate of 5% , with an annual interest payment (known as coupons ), you receive annually € 500 that will be credited to your account bank. Unless, perhaps, to pay taxes on income if you have opted for the standard deduction. Refer to the section of the tax section . O n speaks of compound interest when, at the end of each accounting period, interest is added to the capital to produce new interests. Interest is then called “capitalized” . Between simple interest and compound interest, this is not the nominal interest rate changes is the capital borrowed or placed increases or not during the period of distribution. Example, Booklet A  : At the end of each year, December 31, interest earned on funds deposited are added to the tree as if you had made a payment of this amount. These interests will thus in turn bring interest the following year. When the maximum limit allowed ( € 15,300 ) is exceeded, no further payments (excluding interest) is licensed as withdrawals have reduced the balance below the ceiling.

Nominal – Actual

The nominal interest rate is the rate listed in your loan agreement, one that is actually paid by the borrower to the lender. In most cases, the borrowed capital is also placed or repaid at face value.  For a more realistic estimate of what actually bring your investment or that your loan will cost, we must think in terms “real” and not ” nominal, “that is to say removing the effect of inflation. The simplest is to subtract the inflation rate of nominal interest rate, although the more accurate is to divide one by the other. To calculate the time of signing the contract, must be taken into account expected inflation on the contract.

Generally speaking, inflation tends to enrich the borrower and the lender to impoverish.
The latter, if he has the power demands of nominal interest rates higher to offset rising prices. It may also request that the amount of capital to be repaid is itself re-evaluated in light of changing prices or the exchange rate of currency borrowing vis-à-vis a currency considered more “stable “(called indexing). A relative stability of growth in the general price level is performed for over 10 years (the annual increase is around 2%). This facilitates the calculations used to make decisions in lending and borrowing with greater accuracy and have interest rates long-term and relatively low.

Fixed – variable

The rate of a loan or a loan may be fixed or variable. In a fixed rate loan, the interest rate is fixed for the entire contract period. In a variable rate loan, the contract provides that the interest rate varies depending on the evolution of a given as a reference (price developments, changes in interest rates on short-term loans that banks are between them). For example  : the rate of the booklet A is currently (and since 1 August 2010) of 1.75%. It may be adjusted every six months by the automatic application of a formula that takes into account the evolution of inflation and the other interest rates in the short term. When the interest rate of the booklet has changed – as was the case in May 2009, when it rose from 2.5% to 1.75% – the new rate applies from the date of change to including the stock of deposits (called assets).

For borrowers, it is primarily for long-term debt (eg mortgages) that the choice between fixed and variable rate arises. A fixed rate loan provides the borrower protection against rate hikes interest, but is higher initially than variable rate loan. It does not remove the risks relating to changes in its income during the repayment period. Conversely a borrower chooses a variable rate if it anticipates a decline in interest rates. In contrast, a variable rate loan can prove to be a formidable trap, if interest rates rise, as was shown in the United States in the mortgage crisis at risk.

Annual Percentage Rate (APR)

The interest rates is not the only factor to be taken into account in determining the cost of borrowing or the return of a loan. As this is a savings product, remove the fees paid to the bank where they exist (sales charges, annual management fees, etc.).. And do not forget taxes. As a loan, there are the fees, insurance premiums (death, disability and temporary disability) and guarantee fees.

To compare the conditions borrowing that can be made, it will not suffice to compare the nominal annual interest rates but you will compare the percentage rate (APR) calculated by including all elements of the cost of borrowing in addition to interest rate itself calculated on an actuarial basis.

If the interest rate is the price of silver over a period of time, there are different ways of calculating this price. It is therefore necessary to know what rate we speak. Taking into account certain elements and performing some basic calculations , you can determine the cost of borrowing and make borrowing choices best suited to your situation possible.

The interest rate is the price of money and you do not you borrow for a period and under specified terms. Conversely, the price of money you have and you are ready for some time.

No borrower without lender

There is no the loan without the loan, not borrower without lender. When you put money into a bank book, you lend money to a bank that you borrowed and you should. Lender and borrower are bound by a contract with dates, amounts, amounts exchanged are essential elements.

Performance measurement and cost

The interest rates on the profitability for the lender and the cost to the borrower. This price is expressed as a rate (ratio of interest and the amount loaned / borrowed as a percentage) over time. In general, it establishes annual interest rates. There are several possible techniques and conventions to do so. To compare the interest rate offers of loans or loans, we must verify that the calculations were made ​​using the same method. And to its accounts, it must be remembered that the annual interest rate applies to the amount actually lent or borrowed during the same year.

Save time

When you borrow money, the service rendered to you by the lender is to make you enjoy in anticipation of your future income. For example, you may decide to borrow money two years now to buy the furniture of a bedroom. Or, you can choose to put aside gradually the amount needed to buy the furniture and “cash” in a year and a half. If you borrow, you will pay, for the payment of interest, the gain of one and a half of use of the furniture. If it is a loan to “settle” professionally, the service is not a time saver but a consumer can earn income. Conversely, when you pay the money, the interest rate is the remuneration of abstinence. You waive, for a time, for immediate consumption and, more generally, to have the free use of your money. The longer abstinence and you can, in principle, obtain a high interest rate. Thus, the interest rate used in the book A, where it is possible to withdraw money at any time, is lower than that of bonds whose principal is repaid after 5, 7 or 10 years. Sometimes, very rarely, as short rates move above the long-term rates.

Price of risk

In fact, the interest rate also compensates the risk taken by the lender: the risk of not being repaid (called the risk of failure or default) the risk that inflation devalues the refund . The interest rate therefore includes a risk premium varies according to the confidence in the borrower, the duration of the placement and anticipation of inflation. Banks also protect against these risks by taking mortgages ) as collateral for the loan, or transfer to other part of the risk they support the cause.

A price not quite like other

With any other commodity, the price depends on supply and demand. If there are many loan applications and some loan offers, the general level of interest rates will tend to rise and vice versa. This, to some equilibrium: rising interest rates will limit the demand for money and vice versa.

At the same time it is a price that has particular characteristics.  A loan is a bet on the future and including the future evolution of prices. Lend money at 4% for five years if you think that prices will increase by 5% from next year is to make a stupid bet. More on inflation expectations and the level of interest rates will be high. Price stability and especially the guarantee of a sustainable price stability is an important factor for low levels of interest rates. Such is the situation that we know for many years in several regions (European countries, USA, Japan).  Interest rates play a central role in economic behavior and in determining growth and the level of employment. A rise in interest rates will encourage them to save more and borrow less. Households will buy less housing, businesses will invest less, start-ups will be more difficult, and so on. But if money is “easy” and interest rates too low, there is the risk that production does not follow the request or finance loans with bad projects, ultimately, more and failures risks to the stability of the entire financial system.