Interest Rate Calculator
The Interest Rate Calculator determines real interest rates on loans with fixed terms and monthly payments. For example, it can calculate interest rates in situations where car dealers only provide monthly payment information and total price without including the actual rate on the car loan. To calculate the interest on an investment instead, use the Interest Calculator or use Compound Interest Calculator to understand the difference between different interest rates.
Interest rate is the amount charged by lenders to borrowers, expressed as a percentage of principal, usually for the use of various assets. For the most part, interest rates are expressed annually, but monthly, daily, or any other interest period can also be used. For instance, an 8% interest rate for borrowing $100 a year will obligate a person to pay $108 at year end. However, most interest today is compounded; that is, interest earned by lenders subsequently earns interest over time. The more frequently interest compounds within a given time period, the more interest will be accrued. To do calculations or learn more about the differences between compounding frequencies of interest, use the Compound Interest Calculator.
Interest rate directly affects total interest paid on any loan, and it is in each opposing party's best interest (no pun intended) to get the rates they desire. Generally, borrowers want the lowest possible interest rates. Conversely, investors seek high interest rates.
Interest rate for many loans is often advertised as an annual percentage rate, or APR. APRs are commonly used within home or car buying contexts, and are slightly different from typical interest rates in that certain fees can be packaged into them. For instance, administrative fees that are usually due when buying new cars are typically rolled into the financing of the loan, instead of being paid separately. APR is a more accurate representation than interest rate when shopping and comparing similar competing products (such as cars or homes). For more information or to do calculations involving APR, use the APR Calculator.
Why Interest Rates Fluctuate
Government and Economic Policy
For the most part, interest rates fluctuate due to monetary policy set by federal governments and central banks. For instance, the U.S. Federal Reserve often lowers interest rates to promote spending and boost the economy, which can result in behavioral changes that affect the economy. The most obvious is that people will be more inclined to spend on things that require borrowing, such as home mortgages, car loans, or small business loans because of the lowered fee required to borrow money from commercial banks, who base their own interest rates on those of the central bank. This in turn has an effect on other preexisting interest rates on fixed-income assets such as corporate bonds or Treasury Bills that haven't matured. As a general of thumb, bonds sell for premiums in environments with declining interest rates, and sell at discounts in environments with rising interest rates. As an example, when governments start selling new bonds at lower rates, fixed rates on preexisting fixed-income assets buyable on financial markets are less enticing to borrowers. As an aside, the further bonds are from their maturity date, the greater the disparity between purchase price and face (or par) value paid at maturity. For more information or to find the face value of a bond, use the third calculation in the Loan Calculator.
Interest rate in relation to inflation can be explained by the following equation:
real rate + inflation = nominal rate
In this equation, nominal rate is generally the figure being discussed when "interest rate" is mentioned. Nominal rate is the sum of the general level of inflation and the real rate of interest that is being applied. Therefore, the higher the inflation rate, the more likely that interest rates will rise. In this event, existing loans will have less purchasing power when they mature, so lenders charge even higher interest rates as compensation.
Individual Borrower Risk
The perceived risk of individual borrowers is also a reason why interest rates seem to fluctuate on an individual level. From the perspective of lenders, they are more hesitant lending to borrowers with histories of bankruptcy and missed credit card payments as compared to borrowers with clean histories of timely mortgage and auto payments. As a result, lenders tend to charge higher rates to protect themselves from the likelihood that higher risk borrowers will default. Individual borrower risk is best evaluated through credit reports with detailed credit histories. In U.S., such information can be provided to lenders by the three (previously four) major credit bureaus: Experian, Equifax, and TransUnion.
Getting the Best Interest Rate
Obviously, the best way to get a low borrowing interest rate is to have a good credit rating. But there are other things that can help you: Putting up collateral for a loan or a large down payment for example. You can also reduce a loan rate by using many services (checking, savings, brokerage, and mortgages) from the same bank to get a discount. Also, borrowing when the economy is slow, and demand for loans is low, can give you a better negotiating position.
One sure tactic in getting a better rate is to shop around, trying to get the best deal among a number of banks. You can even tell one bank that another is giving you a better rate, and negotiate. Get the best rate you can, but be careful about conditions and costs involved.