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What is an Interest Rate on a Loan?

What is an Interest Rate on a Loan?

The interest rate is a fee the lender charges to the borrower for borrowing money. It can be a fixed interest rate (only one primary amount) or a variable interest rate (primary amounts vary).

For example, Jesse has a fixed interest rate of 3% on an $800 loan he took out to pay for a home repair project. This means that the interest rate on that loan will remain at 3% for the duration of the loan’s payment plan. Jesse’s monthly loan statements have a consistent amount of money going towards the interest and the principal following the amortization repayment schedule he was given when he agreed to the terms of the loan.

In contrast, Amanda took out a $800 loan to consolidate some of her higher interest debt with a variable interest rate that starts at 3%. Amanda’s interest rate may start at 3% but go up to 3.75% later during the loan. The change in the interest rates will be something Amanda will notice when she reviews her monthly statements because it can affect how much of her payment goes towards the interest and how much will go towards the principal.

The variable interest rate often responds to the market and other factors. When a borrower speaks with an institution, the terms of the interest rate are an integral part of the agreement and are an item the borrower consents to when they take out the loan. It is important for borrowers to know the difference between a fixed interest rate and a variable interest rate before they agree to the terms of a loan, therefore, they won’t be surprised by the amount that goes towards interest when they begin making payments.

Financial Terms and Definitions