What Represents Interest?

20 April 2019 by National Bank
What Represents Interest?

Interest is often referred to as “money rent” because it is a sum that must be paid between the time of borrowing and full repayment, as one would pay rent for the duration they live in a dwelling.

How are interest rates determined?

Interest rates are calculated as a percentage of loan amounts. The interest rate is set according to the type of loan requested, as well as numerous other factors including:

- The rate set by the Bank of Canada, which represents the rate payable by financial institutions for borrowing money. The lower that rate is, the better the terms that banks can offer you, providing that you have good credit;

- Your credit rating, as obtained from your credit file. A better record and a higher credit score makes it possible to obtain lower interest rates. Therefore, the better you manage your credit, the better your overall credit score will be and the less you are likely to pay in interest when borrowing.

Varying interest rates

Depending on the type of credit you use, the interest rate can vary significantly. For example, the interest rate applied to a line of credit is lower than that imposed on a personal loan.

Similarly, interest rates for bank credit cards are typically better than rates imposed on credit cards issued by a department store.

Calculating interest

Interest payable on a loan, a line of credit or a credit card is calculated according to preset rules.

Advertised rates are annual rates, i.e. 19.99% for a credit card. However, the manner in which the amount payable is calculated will have a significant impact on the total amount of interest paid. For instance, if interest is calculated daily, it means that the total amount you owe each day is subject to an interest rate representing 1/365th of the advertised annual rate.

Interest amounts are usually added to the total amount owing at the end of each month. Therefore, any interest that you pay on interest is known as “compound interest”.

For example, if you have a $10 balance and you add $1 in interest at the end of the month, you will pay interest on $11 next month.

Interest rates at your service

If you borrow money, you must pay interest. But, if you invest money in a certificate of deposit, for example, you are the one who will receive interest. In the latter case, the investor is the lender and interest paid compensates for the fact that the investor can’t access the money while the borrower uses it.

It is therefore the power of compound interest that allows investors to grow their savings. If the interest received is reinvested, it will also generate interest, which will grow savings grow over time.

For more information

Compound interest (Wikipedia)

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