Understanding interest rates: A really simple guide

Last updated: 28/11/2022

Understanding Interest Rates: a really simple guide

As soon as you start looking into the world of savings and mortgages, you come across interest rates. But how do interest rates actually impact you, your savings and loans? 

We’ve put together this super simple guide, explaining what interests rates are, why there’s more than one kind, and – most importantly – how they affect you.

If you need a little help understanding other financial jargon, check out our handy guide

What is an interest rate?

An interest rate tells you either: how high the cost of borrowing is, or how high the rewards are for saving.

How do interest rates affect my loans?

If you borrow money – whether that’s to get a mortgage, buy a new car, or to renovate your home – the interest rate is the amount of money you are charged in order to get a loan from the bank or building society. This is shown as a percentage of the total amount of the loan. The higher the percentage, the more you have to pay back.

Here are some examples of the interest rates on a mortgage:

Amount Borrowed Length of loan (years) Monthly Repayment with 1.5% interest Monthly Repayment with 2.5% interest Monthly Repayment with 3.5% interest
£130,000 25 £520 £583 £651

As you can see in the table above, there can be a big difference between paying back your loans with 1.5% interest and paying them back with 3.5% interest.

You can use our Mortgage Calculator to input your details, and estimate what interest rate you would pay on a mortgage. 

Also, read our beginner’s guide to mortgage rates to find out more about the different types of mortgage rates available.

How do interest rates affect my savings?

If you’re trying to save money, perhaps for a deposit on your first home, the savings rate tells you how much money will be paid into your account. 

The savings rate is given as a percentage of your savings. The higher the savings rate, the more will be paid into your account. This can be referred to as return on investment.

Another example: you put £1,000 in a savings account earning 2% interest each year. This means you will earn £20 in interest, giving you £1,020 after one year.

The equation used to work out the interest above is:
£1,000 (your savings) x 2% (the interest rate) = £20 (interest earned)
£1,000 (your savings) + £20 (interest earned) = £1,020 in your savings account after one year

You can work out how much you’d save in one of our savings accounts by using our savings calculator.

What is the ‘Bank Rate’?

The ‘Bank Rate’ is the key interest rate in the UK. It is set by the Bank of England and influences a lot of other interest rates in the economy. Generally when you see news articles about interest rates, they’re referring to changes in the Bank Rate – often referred to as the Bank of England base rate.

Why are high street interest rates different from the ‘Bank Rate’?

As we’ve said, the Bank Rate influences other interest rates, including saving and mortgage rates.

However, there are other factors that lenders take into consideration when setting their interest rates. 

Banks and building societies try to balance the rates they provide to savers and that they charge to borrowers. 

Competition also plays a role, and they also have to cover their costs. 

Will changing interest rates always affect me?

No, not necessarily! For example, if you took out a fixed rate mortgage, your interest rate will stay at the same amount for an amount of time you set with your lender, usually between two and five years. Similarly, fixed rate savings accounts guarantee the interest you receive on your savings remains the same for a set period of time.

But whatever savings account or loan you have, it’s important to stay up-to-date on what the changes in interest rates mean for you personally. 

Click on the buttons below to read more content about saving money:

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