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June 28, 2019 | by QualicoCommunities
If you have ever borrowed money or have a credit card, then you may have heard about interest rates. They play a big role in financial dealings and come with pretty big ramifications for both the lender and the borrower. It’s important to know everything you can about interest rates and how they work. That way, when you’re ready to meet with a mortgage professional to secure a home loan, you can do so with confidence.Here’s the rundown on everything you need to know about interest rates.
An interest rate is a fee a lender charges a borrower for access to a certain amount of money. Interest rates are usually expressed as an annual percentage of the total amount of your loan, also known and the principal. When banks and other financial institutions lend you money for your home, car etc., you’ll pay interest on it. On the other hand, when you save money in your bank account, you earn interest. This is because you’re essentially lending the bank your money.
There are many different types of interest rates available – each with their pros and cons. Understanding them is the first step to making the best decision for your finances and needs. Some interest rates include:
A fixed interest rate is one which stays the same for the entire lifespan of the loan. Fixed interest rates are pre-determined and often used on mortgage loans and other long-term loans. This is beneficial for the borrower because all your payments are the same. This makes it easy to work your interest payments into the family budget. Fixed interest rates give some people piece of mind in case interest rates go way up. But on the other hand, if they go down the borrower will also not be able to capitalize on that low interest rate.
Variable interest rates do exactly that – they vary. These interest rates change depending on the prime lending rate – the rate at which financial institutions lend to their best customers. Although each bank sets its own prime rate, their decision is heavily influenced by the Bank of Canada’s policy interest rate. When you opt for a variable interest rate, you leave yourself vulnerable to market changes – whether bad or good. It’s a bit of a gamble, but can pay off if rates drop.
Simple interest is the most basic of all the interest rates. Simple interest is paid only one time and does not change. There are three important factors to consider when calculating simple interest – the principal loan, the term of the loan and the rate. Let’s say you borrowed a $50 principal, for a one-year term and a 10% rate. After a year, you’d owe a total of $55.
Compound rates charge interest on the principal loan as well as previously earned interest. Simply put, this is a situation where your interest earns interest, and the larger your balance gets, the larger the amount of interest you’ll have to pay.
Lending out money is a risk, even for large financial institutions. Charging interest gives banks and other financial institutions an incentive to lend you money – it’s the premium they receive for taking on the risk. Charging interest is also one of the ways lenders make their profit.
Interest rates fluctuate in order to protect Canadians and the Canadian economy. The Bank of Canada will increase interest rates periodically to reduce how much we’re spending, and how much personal debt we take on. The more interest we have to pay when we borrow money, the less money we borrow. This ensures that Canadians don’t borrow more money than we can comfortably afford – resulting in a more stable economy.
There’s a lot to take in and understand when it comes to interest rates. Don’t hesitate to speak to your financial services provider if you want a more in-depth understanding of interest rates and how they affect your financial situation. When looking to secure a mortgage for a home, get pre-approved, shop around and ask your mortgage broker to work for you in order to secure the best mortgage and interest rate right for you and your family.
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