Complete Guide on UK Interest Rate
This interest rate guide covers interest rates, their work, and the many types of UK interest rates.
What are interest rates?
Interest rates can be either the percentage you earn on your savings or the percentage you pay for borrowing money. Although interest rates can be calculated over shorter periods, they are often represented as an annual percentage. They differ based on the type of financial product you select, the financial provider, and many other factors.
How do interest rates work?
Borrowers and investors are impacted when the Bank of England (BoE) base rate, commonly referred to as the bank rate, changes. Borrowing costs will likely rise if the BoE base rate rises, but savers may see an increase in interest payments. Other factors, such as variations in demand and the interest rates provided by competing banks, could also lead banks to modify their interest rates.
What is the UK base rate?
The UK’s central bank sets the UK base rate, the interest rate commercial banks pay for loans. Banks’ interest rates to save or change the base rate influence borrowers.
Depending on how the economy is doing, the BoE may use the base rate to promote or discourage consumer spending. The BoE can use negative interest rates to promote growth if the economy is exceptionally bad. As of October 2022, the base rate is 2.25%. The website of the Bank of England can also be checked.
Also Read: What Are Green Mortgages And How Its Work
What are the different types of interest rates?
The two main interest rates (typically referred to as AER) are simple and effective.
What is the simple interest rate?
Real and nominal interest rates can be calculated from the simple interest rate. The specified rate used to calculate interest payments or the rate at which savings earn interest over time is known as the nominal interest rate. For example, you would receive £200 in interest if you invested £10,000 at a nominal interest rate of 2% over a year.
By deducting the inflation rate from the nominal interest rate, the real interest rate accounts for the effect of inflation on nominal interest rates. The actual interest rate is 0%. For example, if the nominal interest rate is 2% and inflation is also 2%.
What is the effective interest rate (AER)?
The interest rate applied to savings accounts in the UK is the effective interest rate, often known as the AER or Annual Equivalent Rate.
It is computed by adding the amount you initially invested to the interest you earned on savings over a year. Compound interest, which is what this is, means that any interest earned over the following year will be decided by taking into account both your initial deposit and the interest you earned the previous year.
AER usually compares annual interest rates with various terms for compounding (daily, monthly, annually, etc.). A nominal interest rate of 5%, for example, would be equal to an effective rate of 5.095% when compounded quarterly, 5.116% when compounded monthly, and 5.127% when compounded daily.
Why are there different types of interest rates?
There are different interest rates, as some are more suitable for particular financial goods than others. The following factors, in addition to the base rate set by the Bank of England, affect the interest rates that financial firms charge:
- Account type for savings.
- The residual term.
- The account’s currency.
- Savings and credit estimates at the national level.
How to compare interest rates
Savings accounts cannot easily compare if a financial service provider does not use a standard technique of comparing interest rates. The most crucial information you need to know is whether a financial service provider employs the nominal interest rate or the AER. Find out how frequently interest is computed and if there are any administrative costs. AER is frequently used to compare savings account interest rates because it clarifies how much interest you could earn in total.
The best interest rates in our market are variable, but generally speaking, longer fixed-term savings accounts offer the best bank interest rates. Before applying to banks with the best interest rates, study the details of how they manage savings accounts.