Interest rates play an important role in our financial market; They indicate the cost of loans. In other words, interest rates encourage lenders to provide us with the loans we need and want. The higher the interest rates, the more profitable it is for lenders to provide loans and other financial products. In turn, loans offer countless opportunities for borrowers to spend wisely and invest. In other words, this type of spending creates good debt and can lead to prosperous economic growth. On the other hand, too high interest rates can have a negative impact on economic growth because they often create high levels of bad debt. It is important for all Canadians to understand how interest rates are calculated before making decisions about applying for loans or credit. This article will provide basic information to help you understand general aspects of interest rates.
Fixed rate / variable rate
In general, most loan products offer two types of interest rates to borrowers: fixed or variable. Depending on your financial needs, one may be more beneficial than the other.
A fixed interest rate means an interest rate that will not change for the duration of your loan agreement. This means that you will maintain the same interest rate as your payments are made and until your loan is fully repaid. Managing your finances well is the key to healthy financial habits. This will help you build a good credit rating and allow you to access a variety of different financial products. The best way to organize your finances is to know the exact amount you have to pay. Fixed interest rates can help you anticipate your payments and make sure you have enough money to pay for them. A fixed interest rate is calculated by the financial institutions in the same way as for the variable rate. It can be divided into two parts: the market premium rate and your own risk premium. The first is a base that depends on the market position; We can consider this as the basic cost of loans. Your risk premium is based on your financial history; This is usually found throughout your credit rating. Your risk premium is a percentage that will cover the lender in case you are unable to repay your loan.
Variable (or floating)
The second form of interest rate is the floating rate. As its name suggests, this is a rate that will change as your payments are made. The floating rate fluctuates with the market premium. When the market interest rate changes, your interest rate may be positive for you (lower interest rate) or negative (higher interest rate). When you negotiate your loan agreement, your risk premium will be granted to you in the same way as the fixed rate, based on your financial history. With a variable interest rate you share some of the risk with your lender, this one will offer you a lower interest rate by getting your loan. A variable rate can be a great option when you apply for a short term loan. In Canada, interest rates are stable and fluctuate rarely; This can be a great way to get a lower interest rate without too much risk. For example, the market premium is 3% and your own risk premium is 2%, which means that for the first month, your floating rate will be 5%, in case the market premium drops to 2%. % your interest rate for the following months will be 4%. It is important to take into consideration that the market can change positively or negatively.
Annual percentage rate
There are several ways to display interest rates. When signing a loan agreement, your interest rate can be calculated on a daily, monthly or more often on an annual basis. In fact, in Canada, the law is that any loan agreement must display the annual rate. An annual rate is the percentage of interest you will pay on your loan in a year. For example, if you have a 5% interest rate on a $ 10,000 loan, you will pay $ 500 in interest rates in a year. Here’s another example that can help you understand how you can turn your interest rate into an annual percentage rate. Say you have a 3 month loan of $ 1000, every month you have to pay $ 400 and there is a $ 30 activation fee. According to the calculation below, you are currently paying an interest rate of 23% on a three-month loan. Now let’s look at the calculation of a TPA: The best way to calculate this is first, find the monthly rate, then multiply it by 12 months. In this case, the monthly rate is 7.67% and the annual rate is 92%.
((430+ 400+ 400) -1000) / 1000) = 23% interest for 3 months
23% / 3 months = 7.67% per month
7.67% x 12 months = 92% per year
Interest Rate (Term) = (Number of Payments – Loan Amount) / Loan Amount
Interest rate (monthly) = Interest rate (term) / amount per month / weeks
Interest Rate (annually) = Monthly interest rate x 12 months
Legal limits of interest rates
In our last example, the TPA was 92%. In Canada, this is well above the legal limit. In fact, the allowable limit is at most 60%, including fees and charges. There is one exception to this allowed limit, with the payday loan industry, which is regulated by each province and has different limits. A payday loan is a loan of last resort in which you borrow an amount of money that you must repay on your next payday. This is usually a two week period. Payday lenders charge high interest rates and fees to their clients in order to make short-term profits. Here is a table showing the authorized interest rate caps for payday loans by province.
|provinces||Limit allowed for a loan of $ 100 with a term of 2 weeks||TPA|
|British Columbia||$ 23||598%|
|Prince Edward Island||$ 25||650%|
|New Scotland||$ 25||650%|
Understanding interest rates can help you make better financial choices. This will help you build your credit rating while saving money in the long run. It is important for you to negotiate your loan agreements and look for the lowest possible rates. Make sure you are fully aware of the annual rates and compare them before making any final decisions. Organizing your finances and creating a budget will help you make the right choices before borrowing.