Finance rate refers to the rate at which you can get finance from a bank or any other lender. It is also called interest rate. When you are in need of financing for any purpose, whether it is to buy a car, a house or any asset, you may take a loan. Similarly, when a business needs money it may decide to take a loan. When a lender decides to give you money, he not only expects to get back the money he lent you, he also expects a reasonable return for it, which is the interest. Finance rate or interest rate is a percentage of the loan you take, which you have to pay the lender.
How is it calculated?
Finance rate is calculated on an annual basis. For example, a 7% finance rate, means that the rate of interest charged is 7% of the loan amount or principal. If you have taken a loan of 10,000 then you need to pay 7% of 10,000 every year or 700 as interest. This has to be paid throughout the period of the loan (known as term or tenure). Supposing it is a 10-year loan, you need to pay 700 every year for ten years, which means you have paid 7,000 as the total interest on the loan. So at the end of 10 years, you have to pay 77,000 which is the amount you took as a loan plus the interest.
Types of interest rates
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The example we discussed above is called simple interest, which is the most basic form of interest. It is a straight calculation as Interest rate/100 x Principal.
Another type of interest rate is the compound interest rate. Here, interest is charged on interest. Taking the same example as above, the first year you pay interest of 700, in the second year, the interest rate is 7% of 10,000+700, i.e: 7% of 10.700, which is 749. This increases every year. So here you pay as compared to simple interest. These rates are usually charged by credit card companies.
Amortized interest rates, which is usually charged in home loans and car loans, is where you pay more interest and less principal during the starting years of the loan and in the latter years, you pay more of the principal and less of the interest. The rate remains the same, but as the value of the principal amount changes, the interest paid changes year on year.
Fixed interest rates are those which remain constant throughout the tenure of the loan. A 7% fixed rate means the rate of interest is fixed at 7% and will not change.
The variable or floating interest rate is where interest rates get changed during the loan period. Usually, the interest rate is linked to the market rates. If the rates go down, it is beneficial to the borrower, however, if the rate goes up, then the borrower has to pay more.
The prime interest rate is usually the best rate offered to clients. Such rates are given to high-value clients by banks and other lending institutions. This is the rate that banks pay to each other.
The discount rate is the interest rate with a discount. This is usually given on short-term loans to financial institutions. This is usually calculated based on a cash flow analysis.
Finance rate is the rate at which interest is charged by a lender from the borrower. The interest rate is used to calculate the interest due on the loan amount, which he has to repay during the duration of the loan. This is an important parameter to consider when you take a loan.