Interest Rate Definition, Info & More

Interest Rate

The interest rate specifies the amount of interest that a debtor has to pay his creditor for money borrowed, or that an investor receives for investing capital in a company, for example. The interest rate is always given as a percentage and relates to a fixed period. A period of one year is usual. The period is often given in the form of the abbreviation “p. a “. This abbreviation stands for the Latin expression “per anno” and means per year.

Entrepreneurs who are already writing invoices may claim interest on arrears if the recipient of the invoice repeatedly defaults on payment. You can read how to calculate default interest in our Billomat magazine.

What Is the Economic Significance Of The Interest Rate?

The level of the interest rate has a direct impact on corporate investment and consumer consumption. [b] The most important interest rate is the key interest rate. [/ b] The key interest rate is regularly revalued by the European Central Bank (ECB) and adjusted if necessary. The base rate has a direct impact on the interest rate consumers and businesses pay for money borrowed. The lower the key interest rate, the lower the interest rates on borrowed capital, so that the willingness to borrow money for investments and private consumption increases.

The key ECB interest rates has been at a very low level for several years. That is, borrowing businesses and consumers currently pay very little interest on the borrowed money. On the other hand, the so-called real interest rates that savers receive on their savings are also very low. These real interest rates are also dependent on the key rate of the ECB. The so-called low interest rates policy is intended to increase the willingness of companies and consumers to invest so that the inflation rate across Europe reaches the targeted value of around 2% annually.

What Factors Disturb The Interest Rate On A Loan?

The interest rates determines the amount that must be paid for a loan or the investor will receive for an investment.
Banks take into account several factors when calculating the interest rates on a loan. These factors are

• the key rate of the ECB
• the type of loan
• the term of the loan
• the purpose of the loan
• the creditworthiness of the borrower

The key rate of the ECB:

Banks regularly use the key rate of the European Central Bank (ECB) as a basic guide for the level of the lending rate.

The Type Of Loan:

Banks charge different interest rates depending on the type of loan. A short-term current account loan usually has a higher interest rates than, for example, a long-term loan for a mortgage loan .

The Term Of The Loan:

In principle, the longer the term of a loan, the greater the risk for the bank that the borrower’s financial situation will deteriorate during the term to such an extent that he can no longer service the loan . The interest rates for long-term loans is therefore usually higher than for short-term loans.

The Purpose Of The Loan:

Banks grant freely usable and earmarked loans . Earmarked loans are, for example, loans for mortgage lending. Since with these loans it is known what the money is used for and, for example, with a car loan, the purchased vehicle serves as security, the interest rates is usually lower than with freely usable loans.

The Borrower’s Credit Rating:

The creditworthiness is an important indicator for the lender in assessing whether the borrower will repay the loan or not. The much the credit rating, the safer the bank and the lower the interest rates.

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