Interest is in the terms and conditions of personal loans, credit cards, mortgages and other financial products. Here we let you in on what it’s all about.
An interest rate is a percentage that the borrower agrees to pay for a loan during its term. For instance, if we take out a one-year, EUR 1,000 loan at an interest rate of 5%, the loan will cost us EUR 50. The total amount we'll repay is EUR 1,050. As we’ll see below, there are several types of interest.
What is interest for?
Bank financing can be in the form of a loan or line of credit. Alternatively, if we want our money to yield a return, we can use investment funds, savings plans, remunerated accounts and other products.
Whether we’re the lender (creditor) or borrower (debtor), it’s vital we know how interest works. Three reasons for charging interest are:
Types of interest
Central banks (such as the European Central Bank in the EU) typically set interest rate benchmarks. However, banks are free to set their own rates based on supply and demand.
What about NIR, APR and EIR?
The types of interest we find in financial products are:
How much do you know about interest? Find out by taking this quiz (in Spanish) from Santander Consumer España’s blog, Tu Futuro Próximo (“Your near future”).
Why must we pay interest?
Now we know what interest is and how it’s calculated, we must also learn about fulfilling financial obligations. While interest from savings and investments gives us a return, we also have to pay it on what we borrow.
“Default” or "late payment” interest is charged when a borrower fails to make due repayments. The rate is usually higher to discourage borrowers from paying late. Additional fees could also harm our financial health. Many countries have laws on this type of interest to ensure control. In Spain, the government budget sets a statutory interest rate as the basis for calculating late payment interest.