When you go for a loan or open a savings account in the bank, probably the very first thing you consider is the interest rate. You would always want to borrow money at low rates of repayment, while in the case of savings you’d want the interest to be high.
You need to know how this thing works. Another very important thing about interest rates UK is that they change. You never know when it is coming and you wouldn’t want to be caught unaware. Moreover, it could increase or decrease.
Unfortunately, there is no way of knowing when a significant change might come. Though you can be prepared for it at least, and for that, you need to understand in detail – interest rates explained and how it works.
What is the Purpose of Interest Rates UK?
To say in the simplest terms, you can think of interest as protection from the perspective of the lender. You might ask what exactly does it protect someone from, and the answer is simple. As you see, the prices of goods and commodities in the market keep changing.
Even though they’re not always on the rise, rising prices are the main concern of a lender. At the same time, it is also the reason why they charge interest on their loans. Sometimes, it is also possible that the borrower is unable to pay them back, which is quite a big risk.
Then, there’s also the business aspect, where the interest paid by the borrower is the profit of the lender. Without this, nobody would have taken the risks of lending money to people.
Now, from the perspective of the borrower, interest rates explained are simply the cost to be paid for a service. When you take a loan, it enables you to fulfil your requirements like buying a car, home, or going on a vacation. For this and the risk taken by the person who lent you money, you would be expected to pay a price.
When you put your money in the savings account of a bank, you take the position of the lender, the one taking the risks. The bank, on the other hand, is the one who will have to pay a certain cost. Though in this case, the borrower decides what the interest rate would be. You would just have them say whether you want to lend them or not.
So, interest acts as a motivation for people to borrow or lend money. That in turn maintains the flow of cash in the economy.
What causes a Change in Interest Rates?
When there is a change in interest rates explained, there can be various reasons behind it. To say in simple terms there are forces, some visible and some invisible, that influence whether the interest rates UK go up or down.
Changes in Government Policies
This is a cause that is very much visible and you can spot it from far. When the government makes some significant changes related to financial policies, interest rates UK often get changed. However, this is only in the case of public financial institutions. Soon, the private ones might have to make changes, too, to keep up with the market.
The Rate of Rising Prices
This is commonly known as inflation and can act as a driving force behind rising in interests. Since higher inflation means a lower value of the currency, lenders will be forced to raise the rates at which they rent loans.
Availability of Credit
When lenders are not able to recover the money they lend to borrowers, they would eventually have to increase the rates. There won’t be any other choice as they have to recover the money lost to defaulting borrowers.
If this happens on a large scale, there would be little credit left to be borrowed. As a result, the demand would automatically increase, bringing up the rates further along with it.
Is the Savings Interest that you Receive Taxable?
The interest that you receive on your savings account can be seen as an income. Like in the case of other sources of earning, you have to pay a tax on the amount you receive, if it exceeds a specified limit.
In addition to savings accounts, this category also includes your earnings from bonds, investment trusts, etc. If you want to earn some interest without having to pay tax for it, that’s possible only if your net income is £150,000 or below.
How much Savings Income will be Tax-free?
Under the current regulations, you can earn a fixed amount of non-taxable interest on your savings based on your net income. Also, the tax you’ll have to pay is different for every scale of earnings.
The more you earn, the higher the tax you’ll pay on your interest. The savings allowance amount will also differ with each income scale. That is, the higher you go, the lesser interest you’ll be able to earn on your savings without having to pay tax.
If you earn up to £43,500, you fall in the first income band. As per the regulations, you’ll be able to earn £1,000 or below per annum without having to pay any tax on it, in case you earn above this amount, you’ll have to pay 20% on the additional sum.
Similarly, you would fall in the second income band, if your net income exceeds £43,500 and reaches up to £150,000. In this case, you’ll get to earn up to £500 tax-free on your savings each year. If you earn more than that, you’ll have to pay 40% on the remaining amount.
You can’t avail a personal savings allowance from the government if your net income is above £150,000. In this case, you’ll be charged 45% on any interest that you earn on your savings each year.
On what basis do you receive interest on your savings?
When you open a savings account, you can choose to have your interest paid to you in different ways. By going for a monthly interest arrangement, you can have it paid to your account each month.
There is only one option left for you, apart from this, which is an annual interest. You get it every year on a date that is agreed upon. You can also get a compound interest, which is also paid annually, but with some difference.
Suppose you have got the previous earnings on your savings along with the total amount in the account, then under a compound interest, you’ll get paid interest on that amount as well.
This would be great for increasing the money in your account to grow faster than in the case of other types of interest. However, for a borrower, it would only mean paying more money.
How is the Rate of Interest for Borrowing Money Calculated?
You might have to come across some situations where you have to borrow some money to get through. In that case, it would be quite helpful for you to know how to calculate the interest that you’ll have to pay annually.
The lenders often tell you the monthly rate. If you calculate the total interest that you’ll pay in a year, you’ll find the small monthly amounts add up to quite a big one. That’s why you must always calculate the annual percentage rate (APR).
Now, there must be some cost to set up the arrangement itself. You must include that amount in the one charged by the lender. This way you’ll get a clear idea of what you’ll be paying them overall in a year.
However, you must consult an advisory service as this calculation is quite a complicated one. You won’t get the correct APR by simply adding up the interests and other payments.
How do you get a Loan at the Lowest Rate?
When you go for a loan, the first thing on your mind has to be the interest that you’ll have to pay. You would want this amount to be as low as possible so that you can pay it off easily.
After all, there’s so much trouble you might have to go through if you fall into debt. Your credit score can have the most significant impact on the rates that would be available to you. So, you might want to pay some attention to that in particular as a low credit score signifies your difficulty to pay back lenders.
Consult an advisor, if need be, to help with getting your credit score back in good shape. Also, you can get a loan secured against your home or property to get a good rate.
Further, you must avoid applying to a lender, if you’re not sure that they’ll accept your loan.
If there are too many rejections in your credit file, it will affect your chances to get a good rate. Compare all the offers available to you and pick the best one. You can even avail of interest-free credit. Thus, we have the interest rates explained.