For the temporary provision of capital, the creditor pays the debtor a sum of money – the interest. The amount of this sum is based on the agreement between the two contracting parties and depends on the amount of the loan. The interest rate determines the percentage of the loan amount and thus determines the amount of interest that is payable in return for the principal.
How do interest rates differ?
As a rule, the interest rate refers to one year. However, there are also interest rate variants that calculate a monthly interest amount or the rate for a quarter. In Germany, an interest calculation method is used that calculates 30 days every month and accordingly a year with 360 days. In general, a distinction is made between the following types of interest rates:
- The nominal interest rate is the pure interest rate that enables the interest amount to be calculated.
- The real interest rate, on the other hand, is the interest rate adjusted for the effects of inflation.
- The effective interest rate also includes all relevant variables that can influence the amount of the interest. These include the payment rate or additional costs.
What is the compound interest?
In the case of an interest-bearing investment, the point in time when the interest is paid out is decisive, since the total amount of interest changes and the amount of the following interest amounts also increases accordingly. This effect, known as compound interest, results in an advantage for the creditor the more often the interest is paid out.
Fixed and variable interest rate
It is also important to distinguish between a fixed interest rate and a variable interest rate.
A fixed interest rate is set in the contract at the start of a money transaction and does not change in value until the end of the contract. In the case of a contract with a variable interest rate, on the other hand, this is changed within the term of the contract, whereby this change is based on the real developments on the capital market and depends on the key interest rate.