This can be imagined is a simple question that everyone should know the answer to but unfortunately it is not at all. Many people, for example, who have been in financial trouble, simply have too little control over what interest rates are. Therefore, it is time for me to review this word.
What interest rates are and other things that you really need to know should be what the schools teach, but unfortunately it seems to be bad on that front. Personal finance should be one of the most important things to teach at secondary school / high school. Learning to play drums (really hated it) or some more advanced math, for example, is something very few people will have any use for in the future. Without doing a more thorough investigation, I feel pretty confident that significantly more in the past month have paid a bill than the number who have played drums.
It should be a great basis in school to teach what to think about in our everyday lives. Maybe the schools have gotten better since I left the system, but for them to be good I find it hard to believe as many young people end up in big problems.
Interest is the price that someone pays when borrowing money
If you deposit money into a savings account, it is the bank that borrows money from you and thus you get paid in the form of the interest they pay. On the contrary, if you borrow money from a lender. The most common is that you talk about annual interest, which is the interest you have to pay per year, but there is nothing that says it must be so.
Say you borrow SEK 10,000 from someone and you decide that the interest rate should be 10%. This means that you will pay SEK 1,000 in interest as it is one tenth of the loan amount. Should you repay the entire loan at once, it would therefore cost you 10,000 + 1,000 SEK to settle the entire debt.
When you borrow, however, it is common for the repayments to be split up on several occasions and it is then that it becomes a bit more advanced to figure out how much to pay. We take and continue with the example of a loan of SEK 10,000 with 10% in interest and say that you repay this loan on five occasions and that you pay interest each time. To make it easy, we also use straight amortization (always amortizing the same amount).
|loan Total||Interest||Interest in kr||Amortization||Amount|
|10 000 kr||10%||1 000||2 000||3 000|
|8 000||10%||800||2 000||2 800|
|6 000||10%||600||2 000||2 600|
|4 000||10%||400||2 000||2 400|
|2 000||10%||200||2 000||2 200|
|0||3 000||10 000||13 000|
In our example with the loan, it would therefore cost SEK 3,000 to borrow this amount. Then, of course, this was a very simple example to show how it works. If you take out a mortgage loan, for example, it may be repaid over 50 years and the borrower pays every three or every month. We are therefore talking about between 200 and 600 repayments on the loan, which would make the example much more difficult to print.
Don’t just check interest rates
It’s not really that simple that you can just check the interest rate that the lender says they charge for the loan. This is because several other costs can also be incurred for a loan such as a management fee, a setup fee etc.
If the loan has no other costs, the interest rate they print will also be what it will cost you. But if there are other costs as well, something called effective interest rates is a good way for you to find out what the loan really costs. The usual interest rate that the lenders write up is called nominal interest rate and is only what they charge extra for the loan. Lenders want to make a profit when they lend money and it is only through interest that they are allowed to withdraw this profit. Planning fees or other fees may only be used to cover the actual costs they incur for them.
Effective interest rate
Effective interest rates are a good measure as the lenders here must take into account all costs associated with the loan. In other words, nominal interest rates, fees, etc., and then this is presented in a percentage figure on an annual basis. So if you have a private loan of SEK 100,000 and that has an effective interest rate of 8%, you have to pay SEK 8,000 for the loan itself in the first year (now we do not expect you to repay during the time to make it easy). The loan could have a nominal interest rate of 7%, which would mean that you have 1% in other costs.
Just keep in mind that effective interest rates are calculated on an annual basis, which is why strange results can be obtained for loans that do not have a maturity of one year but a shorter period of time. Therefore, you cannot directly compare a micro loan of 3 months with a private loan of 1 year when it comes to effective interest rates. Effective interest rates should only be used to compare similar loans.
Variable and fixed interest rates
These are two simple but important concepts to understand when it comes to interest. Fixed interest rates mean that you and the other party decide that for a certain period of time a certain interest rate applies. This is then fixed during the period regardless of what happens. It is usually with fixed interest rates, for example, for mortgages where it is possible to fix the interest rate for 1 – 10 years with most lenders. It is normally only for mortgage loans that this is something that you should consider.
Variable interest rates are governed by the market interest rate or any index. This means that the interest rate can change with fairly short notice and can then both go up and down.
Advantages and disadvantages
The risk is greater with variable interest rates since it can go up but at the same time it is probably the cheapest too. Historically, variable interest rates have been cheaper. Then there may be times when it fits with fixed interest rates for everyone.
Another good rule of thumb might be that if you have good margins in the economy, it is better to have variable interest rates when you can save money. If you have smaller margins, it is not worth the risk that the interest rate goes up so much that you cannot afford your payments and then it is better to take the “safe” alternative in the form of fixed interest rates, although it probably costs a little more.
There is more
Of course, there are more advanced things that concern interest, but this is something you don’t normally have to worry about directly why we haven’t looked into this in our simple review either. The idea was to make it as easy as possible to understand and then you just have to look at the basics.
It is enough for you who will borrow money to know what it will cost you not exactly why it will cost you X number of kronor.