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What are interest rates?

An interest rate is a percentage of a loan or savings that’s added on to the entire amount.

What are savings account interest rates?

Some savings and investment accounts allow you to earn interest simply by keeping money in the account. Basically, it is how much your bank will pay you for saving with them, given as a percentage.

When you borrow money from a bank or building society, an interest rate is the amount you will be charged for doing so and usually appears as an annual percentage of the loan.

On savings accounts, you'll usually see the interest rate referred to as AER (Annual Equivalent Rate). On borrowing products, it's normally called APR (Annual Percentage Rate) and will often also include any fees and charges as well.

Both AER and APR make it easier to compare products to see how much you could earn or pay in interest.

How do interest rates work?

In the UK the 'bank' or 'base rate' is set by the Bank of England (BoE), which in turn influences the interest rates set by banks. If the BoE base rate happens to increase, you may see an increase in the interest rate set by your bank. This means you are likely to pay more interest on any loans or amount you have borrowed from the bank.

However, for any savings you might have with your bank, you could also see an increase in the amount of interest you earn - this is because the bank will essentially be paying you more to keep your money in your savings account.

When looking at interest on savings accounts, we also have to think about compound interest.

What is compound interest?

Compound interest is where you earn interest on the interest you've already earned - whilst it sounds complicated, it can have benefits for savings and investments accounts.

For example, if you deposit an amount into a savings account with compound interest, you will earn interest on that deposit amount in the first year.

In the second year you would earn interest on the original amount, presuming you don't add or take out any money. But you would also earn interest on the interest you earned in the first year. For every year after, you will continue to earn interest on the original amount plus all the interest from following years.

With a compound interest savings or investment account, you may be able to grow your funds quicker than if you have an account with simple interest.

 

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