All you need to know about interest rates

Every banks wants to make money with its customers – you should be aware of that when you apply for a loan or if you want to make use of one of the other services offered by a bank. One way of earning money for a bank are interest rates that customers have to pay in addition to the loan instalments. How high the interest rates are, is dependent on the bank. It is therefore advisable to make a detailed comparison of loans, e.g. on a comparison website. As high loans with a long life often mean that you have high interest costs, a comparison can save you a lot of money.

To have you prepared for your bank appointment, we will explain in the following how banks decide on the height of their interest rates and what you need to pay attention to when applying for a loan.

Base rate

The base rate is an interest rate that is set by the respective central bank based on the current monetary policy. In the Euro area the European Central Bank defines the base rate. It influences the conditions under which banks can borrow or invest money. The conditions are then transferred by the banks to their customers. If the base rate is low, bank customers can take on a cheap loan. If the base rate is high, conditions worsen for the debtor, as well.

Borrowing rate

The borrowing rate is the interest rate you agree on with your bank in your loan contract. In some cases, you have a fixed interest rate for a certain period of time. During this time, the bank is not allowed to change your interest rate in either direction. If the fixed interest rate does not cover the whole borrowing period, you will have to agree on a new interest rate once it has expired. When applying for a loan, you should be aware if this loan has a fixed interest rate and if so, how long it is running.

If there is no fixed interest rate, one speaks of a variable interest rate. In this case, the interest rate will be adjusted in regular intervals based on the current market situation. Depending on the development of the financial markets, this can have both, a positive or a negativ impact. You should be aware of this – particularly if your interest rate is very low at the beginning, you should not be blinded by seemingly irresistible offers.

Today, there are many loans whose interest rates depend on the solvency of the debtor. If someone with a high solvency wants to get a loan, he will receive better conditions than someone with a bad solvency score.

Effective rate

The effective rate is your interest rate including all costs you might have to pay whilst applying for a loan. Therefore, the effective rate is a good parameter to show all costs the bank customer has to pay. In makes sense to use the effective rate to judge the value of a loan offer and to explicitly ask your bank consultant for this rate. Attention: The costs for a residual debt insurance are not included in the effective rate .