Loan interest rate

People who take out a loan receive a specific loan amount from a bank or from a private lender at a set loan interest rate (also loan interest). They must either repay this in small installments, which include the cost of the interest, over a longer period (also called the term), or they must repay the total loan amount at a fixed agreed date. When applying for a loan, the lending institution usually also checks your creditworthiness with Schufa. Creditworthiness is important to the lender because they want the assurance that the installment loan can be repaid within the agreed term. Schufa can provide information about your creditworthiness because all entries, whether positive or negative, are recorded there.

What is the loan interest rate?

A loan can be very helpful in many situations. Especially when buying or building a house, most people depend on a loan, but loans are also common for other larger purchases. Buying a new car, a costly renovation work on your home, or another major expense can also make a loan necessary and thus loan interest will be charged.

In many cases, loans are useful even for smaller purchases because the needed items are available immediately and the borrower does not have to save for a long time to buy them. A loan is often very helpful, but it always has its cost.

Banks charge a loan interest rate for providing the loan amount. This means that the borrower must not only repay the loan principal but also pay somewhat higher amounts (loan interest) to cover the bank's services. Interest is therefore a kind of consideration that the borrower pays to the lender. Interest can also be seen as a kind of fee for borrowing the loan amount. The loan interest rate can be stated in different ways.

The nominal loan interest rate

Calculating an interest rate is common in financial transactions. If a saver, for example, deposits money with a bank, they receive interest for it. If, on the other hand, you borrow money from banks in the form of a loan, you have to pay loan interest.

If you receive interest on a savings balance, it is shown as credit interest. If you have to pay interest on a loan, this is called debit interest (interest payable). The amount of interest depends on the amount on which interest is charged and on the agreed interest rate. These must be repaid together with the loan principal within the planned term.

More information at: Interest rate on loans.

Calculation example for the nominal loan interest rate

Loan interest is usually calculated once a year. For example, if you take out a loan of 10,000 euros at an interest rate of 5%, 500 euros will be due after one year. However, for most installment loans, the installments must be paid every month. In this case, the loan interest rate is recalculated for each period.

If, for example, you repay 100 euros every month, after one month interest is only calculated on a loan amount of 9,900 euros, after another month only on 9,800 euros. To enable this calculation, it is necessary to determine the loan interest rate for each individual day.

This ensures that you only pay interest on the amount that was actually borrowed at the respective time. Nominal loan interest rates can differ significantly between different loan offers. Therefore it is always important to compare the interest rate and the other conditions of different loan offers carefully. By comparing offers you can also save a lot of money by getting better interest rates. Conditions such as the term can also be influenced by planning the installment amount and should therefore be considered carefully beforehand. Therefore, comparing offers is always advisable.

The effective annual interest rate

A loan does not only incur loan interest; there are many other fees as well. Many banks charge, for example, an administrative fee and a loan fee. Interest-free years can also affect the actual price the customer has to pay for the installment loan. In addition, there are different methods of how repayments are offset, which can also affect the final payment amount. These additional costs mean that the nominal interest rate is only one of several factors that determine the amount of the monthly installments.

Therefore, it is often difficult for consumers to compare different loans and their conditions. The actual burden of one loan can therefore be higher than that of another loan, even though the nominal interest rate is actually lower. For this reason, there is a law in Germany that obliges banks to state not only the nominal rate and the various processing fees in a loan agreement but also the effective loan interest rate. This indicates the total cost of the loan and includes both the loan interest and all other fees. Therefore, the effective annual interest rate should always be used for comparisons instead of the nominal rate. The nominal rate only reflects the pure interest costs, whereas the effective loan interest rate, also called the effective annual interest rate, includes all costs. The nominal rate can also be regarded as a kind of borrowing fee.

Disclosure and calculation of the effective annual interest rate

The legislator has also specified a procedure by which the effective annual interest rate must be calculated. This uniform procedure is intended to ensure that the effective annual interest rate is calculated in the same way by all banks and actually reflects the total cost of the loan. For this reason, it is always more important for consumers to compare the effective annual interest rate. If a customer only compares the nominal rate, the costs of the loan can still differ significantly.

In a loan agreement, the effective annual interest rate is also mandatory. If the figures in a loan agreement are calculated incorrectly and the values arising from the fees and the nominal loan interest rate should be higher than the stated effective annual interest rate, the bank is always obliged to lower the nominal loan interest rates so far that the agreed effective annual interest rate is met.

Compare loan interest rates quickly and easily

If you need a loan and want to compare different loan offers, it is always sensible to pay primary attention to the loan interest rate, especially the effective annual interest rate. This enables you to assess the total cost of the loan at a glance and thus compare it better with other loan offers.

If you are looking for an affordable loan, it makes sense to use an online loan calculator. This will show both the nominal rate and the effective annual interest rate. To keep the total costs low, it is always sensible to choose the offer with the lower effective annual interest rate.