Interest on loans or savings products is normally calculated as a percentage of the capital or principal sum. The interest rate, the method of calculating interest and the time period are decisive factors that influence the amount of interest.
Types of interest
There are different types of interest calculated depending on the type of financing or investment. Here are some of the most common types of interest:
- Simple interest: this is the simplest type of interest where the interest rate is applied to the original amount. For example, if you borrow 1000 euros for a year at a simple interest rate of 5%, you will have to pay 50 euros in interest at the end of the year.
- Compound interest: Unlike simple interest, with compound interest, the interest is calculated on the original amount and on the interest already accrued. This means that your money increases faster than with simple interest. For example, if you borrow 1000 euros for a year at a compound interest rate of 5%, then at the end of the year you will have 1050 euros (1000 euros 50 euros in interest) and the next annual rate will be applied to this amount.
- Nominal interest rate: The nominal interest rate is the stated percentage that you pay or receive for a financing or investment. However, it does not take into account inflation or other factors such as taxes and fees.
- Effective interest rate: The effective interest rate takes into account all costs associated with a financing or investment and indicates how much you actually pay or receive. It also takes into account inflation and other factors such as taxes and fees.
- Fixed interest rate: A fixed interest rate remains unchanged for the entire term of a financing or investment. This means that you always pay or receive the same interest rate, regardless of changes in the market.
- Variable interest rate: A variable interest rate can change over time and often depends on external factors such as the prime rate. This means that you can pay or receive more or less interest depending on how the market performs.
It is important to understand what type of interest rate applies to your financing or investment in order to better assess the costs and risks.