Interest Rates Explained

Simply put, interest rates determine the amount paid by borrowers (debtors) for holding money from lenders (creditors). These rates are usually expressed as a percentage of an amount paid for a period of one year, however, they are also sometimes calculated over shorter periods. Offered interest rates vary from product to product and from bank to bank, with a number of factors contributing to the rate of interest.

When investors devote capital to a financial product, the bank is in effect borrowing the money. The interest is the price paid by the bank for leaving the money with them for a fixed period of time. For example, an investment of EUR 10,000 for one year with an interest rate of 2% means the investor will receive a total of EUR 200 in interest at the end of the term.

With Raisin, investors typically have the option to withdraw their funds or reinvest them in another fixed-term product. This is where compound interest becomes relevant as an investor will also accrue interest on the interest of their last fixed term deposit should they choose to reinvest their capital.

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Types of Interest Rates

There are essentially three main types of interest rates: the nominal interest rate, the effective rate, and the real interest rate.

The nominal interest of an investment or loan is simply the stated rate on which interest payments are calculated. Essentially, this is the rate on which savings accrue interest over a period of time. For example, an investment of EUR 10,000, at a nominal interest rate of 5% over 1 year, would earn the investor EUR 500.

The effective interest rate (AER) takes into account compounding over the full term of the investment. It is often used to compare the annual interest rates with different compounding terms (daily, monthly, annually, etc.). This means that a nominal interest rate of 5% compounded quarterly would equate to an effective rate of 5.095%, compounded monthly at 5.116%, and daily at 5.127%.

Finally, the real interest rate is useful when considering the impact of inflation on nominal interest rates. In essence, the real interest rate deducts the rate of inflation from the nominal interest rate. This means that if the nominal interest rate is 5% and the inflation rate is also 5%, the real interest rate is effectively 0%.

What Factors Determine Interest Rates?

There are a number of factors that determine the interest rates offered by banks in return for your investment. These include; the chance of default by the borrower, the residual term, the payback currency, the respective country credit rating, the number of commercial banks in the country, and the national projections of savings vs. credit. The type of savings account chosen is also a determining factor.

The Raisin Platform

The Raisin platform offers fixed-rate bonds from partner banks across Europe, making it easy for investors to compare the best interest rates in a number of countries. With our intuitive platform, customers can compare rates between banks and countries in just a few steps. Convenient and hassle free, the Raisin platform makes managing your funds quick and simple. Plus, for complete peace of mind, all deposits are secured by the banks’ respective national deposit guarantee scheme. Lastly, Raisin is completely free of charge with no hidden fees further down the line. So, find the best interest rates and make the most of your savings with Raisin.

As of June 7, 2016