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Advantages & Disadvantages of Interest Rates

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By: Victoria Lee Blackstone
Reviewed by: Ryan Cockerham, CISI Capital Markets and Corporate Finance
Updated November 21, 2018
Whether you’re shopping for lenders in the pursuit of a loan or you’re comparing investment vehicles for your hard-earned money, you'll likely want to find the best interest rate for your transaction. If you’re paying the interest on a loan, you’ll want the lowest rate possible, but if you’re earning the interest on an investment, you’ll want the highest rate possible. Regardless of which side of the “interest fence” you’re on, interest rates are key considerations for borrowers and lenders. The advantages and disadvantages of interest rates don’t conform to a standard model that works for everyone because of the intricacies of their profit-and-loss applications, although some basic principles apply across the board.
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Interest rates provide their own fair share of advantages and disadvantages for lender and borrower alike. In various situations, raising or lowing an interest rate could prove to be advantageous for both parties.
What Are Interest Rates?
In the world of banking and finance, “interest” represents the rate a lender charges a borrower for extending a loan to the borrower. Lenders comprise a diverse group, which includes individuals, banks, corporations, municipalities and credit card companies. On the flip side, interest also represents the amount an investor earns on an investment. Interest rates are typically expressed as a percentage or portion of the amount of money that is borrowed or invested.
Types of Interest Rates
The different types of interest rates can sometimes even keep financial professionals on their toes while trying to understand them. Some types that may be most familiar include simple and compound interest rates as well as fixed and adjustable interest rates. But there’s a type of benchmark interest rate that has a trickle-down effect on most of the other types – the prime interest rate. Also called the prime lending rate, the prime interest rate is a benefit that the most creditworthy people enjoy. Banking customers, for example, who have the best credit scores can get the lowest interest rates for loans the bank makes. Lenders typically look to the prime lending rate as a starting point from which they determine their interest rates for customers with varying credit scores.
Simple interest is applied toward the original amount of a loan, also called the principal amount, and compound (or compounded) interest is applied toward the unpaid principal amount plus the accumulated interest from prior periods.
Fixed interest rates do not change over time, but adjustable interest rates fluctuate (or adjust) over time. An adjustable rate mortgage (ARM) is an example of this fluctuating interest rate. Interest rates on ARMs can vary widely, depending on the terms of the loan.