A Matter of Interest! How Loan Interests Work

So, you're thinking about taking out a loan. But before you sign on the dotted line, it's important to understand how interest works. Interest is essentially the cost of borrowing money. It's the extra amount you'll pay back on top of the original loan amount.

Types of Interest Rates: Two main types

All About Amortization

Amortization is an accounting technique that helps spread out the cost of your loan over a set period. At the beginning of the loan, a larger portion of the payment goes toward either paying for the principal or interest, and this slowly switches to the other depending on the loan type. 

In a home loan, for example, your early payments will focus more on building equity in the house (paying down the principal) while a larger portion later on goes towards interest.

Factors Affecting Interest Rates

Several factors can affect the interest rate you'll be charged on a loan:

• Credit Score: Your credit score is a measure of your creditworthiness. The higher your credit score, the lower the interest rate you'll likely be offered.
• Loan Amount: Larger loan amounts may come with higher interest rates.
• Loan Term: The longer the loan term, the higher the interest rate may be.
• Type of Loan: Different types of loans, such as personal loans, car loans, or home loans, may have different interest rates.
• Economic Conditions: The overall state of the economy can also influence interest rates.

Understanding Interest Rates

When comparing loans, it's important to look at the annual percentage rate (APR). This is the total cost of borrowing, including the interest rate and any fees associated with the loan.

Tips for Managing Loan Interest

• Shop around: Don't settle for the first offer you get! Compare interest rates from different lenders to find the best deal.
• Make extra payments: Putting extra money towards your loan each month can significantly reduce your total interest paid and accelerate your debt payoff.   
• Consolidate your debts: If you're juggling multiple high-interest loans, consider consolidating them into a single loan with a lower interest rate.

Understanding loan interest empowers you to make informed financial decisions. By knowing the different types of interest rates, the factors that affect them, and how to manage them strategically, you can maximize your borrowing experience.

Want to know more about the different loan types available at BPI as well as its functions? Head over to the Loans | BPI to learn more! For more financial education content, visit NEXT by BPI Preferred’s The Program.