An interest rate is the amount charged for borrowing money. Interest rate is expressed as a percentage of the total amount of the loan. Interest rates are typically noted on an annual basis, known as the annual percentage rate (APR). The interest rate, set by your bank and based on the Reserve Bank of India's official cash rate, determines how much interest you will earn or pay.
The assets borrowed could include cash, consumer goods, and large assets such as a vehicle or building.
You are paying the cost for the ability to use money you haven’t yet accumulated, so interest is an incentive for the bank or a lender to lend you money. Charging interest is one of the ways lenders make their profit.
The formula to find an interest rate of a loan is:
Interest Rate = (Total Repayment Amount - Amount Borrowed) / (Amount Borrowed)
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Using the interest rate formula, let's make a calculation for illustration purpose.
Let's assume that you took a loan of INR 20,00,000 for personal purpose. If a lender agrees to lend you INR 20,00,000, but you have to pay INR 25,00,000 at the end of the year. Let's calculate-
(INR 25,00,000 repaid - INR 20,00,000 principal) to borrow the money.
This translates to:
Interest Rate = (INR 5,00,000) / (INR 20,00,000 ) = 25% interest
There are also a couple of different types of interest rates, they include:
A fixed interest rate is set at a certain percentage for the life of your loan or account. Here you’ll pay the same amount of interest each month.
A variable interest rate does just what the name suggests too - it varies. Depending on the market and the RBI's official cash rate, your lender might raise or lower interest rates and those changes will affect the amount of interest you pay or receive.
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