Interest rates investigated

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Interest rates play a huge part in our lives that it is vital that we understand how it works, and how to make it work for us.

An interest rate the reward the lenders receive for parting with their cash, and the cost consumers pay for having access to that cash. The rates are charged on the basis of the principle, the higher the risk, the higher the reward’, which means the more chance there is that the lender will have difficulty getting the money back, the higher the rate charged will be.

In an economy, interest rates originate from the Bank Rate, which is the rate at which the Reserve Bank will lend to the commercial banks. This rate tends to be 3% below the Prime rate. This is the same rate at which a bank will lend money to its top or lowest risk clients.

The banks lend at different rates and offer clients variable concessions, which are expressed as a percentage to Prime rate. When a rate is variable, floating, linked or fluctuating, the concession of 1% stays constant, whilst the Prime rate may move depending on the interest rises or cuts implemented by the monetary policy.

It is the homeowner’s responsibility to negotiate the best concession at the beginning of the loan agreement and then to check from time to time that it is still competitive and get any reduction in writing!

To mitigate the risk of interest rate increases, homeowner’s may decide to fix their rate for a period of time. This fixed rate is normally above Prime rate. So whereas a variable rate of Prime 1% may be quoted, a fixed rate for one to two years may be at Prime + 1%. The decision to fix the rate really depends on what the homeowner’s expectations are of the future interest rate movements. However, what is absolute is that the certainty of a constant, fixed rate comes at a price and this decision should not be taken lightly.

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