Interest rates explained

When it comes to interest rates, it is often just assumed the higher the number the better. In some ways this is true, but that is only if you are comparing the same type of interest rate. It is important to understand which interest rate works for you, and then compare the different numbers. Furthermore, interest rates do not just come from nowhere, and are directly linked to your own credit score. This guide will take you through all you need to know about interest rates and how you can get the best deal for yourself.

In This Guide:

What interest rate should I look for?

This is entirely dependant on the reason you are looking at interest rates. The key thing is to find out what interest rate affects you, and not to be fooled by websites claiming to have the best interest rates. There are different types of interest rates which will affect how much money you will get from your investment. This means it is key to compare types of interest rates, to figure out what will you give you the best return on your investment.

Basic interest rate

If you are looking to save in a relatively straightforward way, a standard interest rate is often what people will go for. Let us say for instance you wanted to invest R10,000 in a 5 year savings bond with a standard interest rate of 12% per annum. This means that every year you will get paid 12% of R10,000, or R1,200 a year.

Annual compounding interest rate

There is another main form of interest rates which is called ‘compounding’. This essentially works very similar to a basic interest rate but instead you will be earning interest on the interest you have already made. To explain this, let’s use the same example as above. If you have invested R10,000 with a 12% you will have made R1,200 after the first year. When this happens, the next year your interest will be 12% of the initial investment + the interest made, so 12% of R11,200, or R1,344.

How do I get a better interest rate on my loan?

Interest rates depend on a wide variety of factors, but unlike other aspects of the loan you can often have the ability to determine your interest based on your actions and therefore you can achieve the lowest one possible.

Your lender matters

Just like every loan is not the same, every lender is not the same. A surefire way to get a lower rate is to only borrow from a responsible lender that is regulated by the proper authority. Often, lenders will be set up to cater to exclusively those borrowers who cannot borrow elsewhere so they have high interest rates, in order to make their money back as quick as possible.

Credit score

The Interest rate that you receive is not just a number that comes from nowhere. It will in fact be based entirely based on your credit report. Your credit report is your financial history, or your history of borrowing. This report then produces a score, which is the financial institutions judging whether you have been a reliable borrower. The general rule of thumb when it comes to credit scores is the higher the better.

How can I improve my credit score?

There are a number of surefire ways you can improve your credit score:

  • Spend responsibly: before you get into any debt, make sure that you can afford it! Credit reports last so you don’t want any mistakes you make now to affect your future.
  • Get out of debt: The best way to improve your credit score is to get out of debt as soon as you can, budget wisely and make sure you keep up with your monthly payments.
  • Borrow: if you are a young person or a student, you might find that your credit score is low because your financial history is very short. The best way to build your credit score is therefore borrowing and paying back on time. The key thing to remember here is that having no credit history is better than a bad credit history, don’t borrow if you can’t afford it!
  • Consolidation loan: this is a good solution for those who find themselves in a lot of smaller debts and finding it unmanageable. A debt consolidation essentially puts all of your smaller debts into one more manageable one.
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