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Common Types of Interest Rates that Bank Use

Financial companies offer loans at that offer a variety of terms and conditions. In this article we will take a look at some of the most common types of interest rates that banks and other financial organizations use.

Let’s begin by understanding a common term called Compounding.

What is Compounding Interest?

Compounding simply means that the specified interest on a loan will be added to the interested that has already accumulated.

Annual Percentage Rate (APR)

Annual percentage rate (APR) is a financial term that is quoted by many financial firms that offer loans. It is simply an interest rate charged for the whole year. APR typically includes loan fees in addition to the compounded annual interest.

Let’s look at an example. Suppose that you have acquired a loan of $3,000 that comes with a 24.99% APR. At first, it may seem that you might have to pay a net sum of $3,749.70 at the end of the year. However, in reality you would have to pay more than that. If the financial company compounds monthly you will be required to pay $3,841.82 at year’s end. The net amount paid will be greater if the loan is compounded weekly or daily.

Annual Percentage Yield (APY)

Annual Percentage Yield (APY) is quoted by financial firms and banks on savings deposited by the individuals in their accounts. Similar to APR, an APY denotes annualized rate of interest. However, the interest rate is paid by the financial company instead of charging it to the customers. It represents the percentage amount you will earn in case the balance remains in the account for a whole year.

The actual amount that individuals will receive depends on how the company compounds the rate. If the rate is compounded yearly, the net interest amount will be lower as compared to when the rate is compounded monthly or weekly.

Again let’s look at an example to further clarify this point. Suppose that you have $5,000 in an account. With a 4% APY, you will have $5,099.03 in your account after six months, and not $5,100, if company compounds annually. The net amount you will receive will be greater in case the company compounds monthly, weekly, or daily.

Before obtaining a loan, individuals are advised to conduct thorough research to understand the amount that they would be expected to repay to the financial institution. The effort and time spent in knowing about the loan terms and terminologies will be more than worth it in the end, as it will help in avoiding undue financial hardships in the future.

Disclaimer Notice: The article is written for information purpose only. We are not liable for any loss incurred due to the use of implicit or explicit information provided in this article. You are advised to should seek expert financial help before making any financial decisions.