This guide to interest rates explains what they are, how they work, the different types of interest rates and how best to compare savings accounts with different interest rates.
An interest rate is either the percentage you earn from the money you’ve saved or the percentage you’re charged for the money you’ve borrowed.
Interest rates are usually expressed as an annual percentage, but they can be calculated over shorter periods. They vary depending on the financial provider and the type of financial product you choose, as well as various other factors (more on this below).
Interest rates can change in line with changes to the European Central Bank (ECB) base rate (also known as the bank rate), impacting both borrowers and savers. If the ECB base rate goes up, the cost of borrowing will probably increase, but savers might earn more on their deposits. There are countless other factors that could influence banks to change their interest rates, including changes in demand and the interest rates offered by other banks.
There are two main types of interest rates; the simple interest rate and the effective interest rate (typically referred to as AER).
The simple interest rate can be broken down into the nominal interest rate and the real interest rate. The nominal interest rate is the given rate on which interest payments are calculated or the rate on which savings earn interest over time. For example, a deposit of €10,000 at a nominal interest rate of 2% over one year would earn you interest of €200.
The real interest rate takes the impact of inflation on nominal interest rates into account by deducting the rate of inflation from the nominal interest rate. For example, if the nominal interest rate is 2% and the inflation rate is also 2%, the real interest rate is 0%.
The AER (Annual Equivalent Rate) is a way of illustrating the interest rates of savings accounts in Europe. It shows how much you could earn from a savings account if the interest was calculated daily, compounded annually and paid after 12 months. The AER is an illustration of how much you could expect to earn per year and makes it easier to compare savings accounts.
APR stands for Annual Percentage Rate. APR is the interest rate displayed when borrowing money and includes any fees incurred when you take out a loan. Just like the AER for savings accounts, the APR is useful because it sets a comparison benchmark for loans.
Different interest rates exist as some are better suited to specific financial products than others. As well as the ECB’s base rate, factors that determine the interest rates offered by financial providers include the following:
Fixed rates of interest allow you to know exactly how much you’ll pay back on a loan or earn from a savings account, and this amount won’t change, even if the ECB base rate changes. For example, with a fixed rate savings account, you can lock your money away for a set period of time at an interest rate that stays the same from the day you open your account until the end of your term. Fixed rate bonds can be preferable during times of uncertainty, as you don’t have to worry about interest rates dropping.
A variable rate of interest allows your financial provider to increase or decrease your interest rate at any time. A financial provider will typically do this in response to a ECB base rate change, but other factors can result in a rate change. For variable rate savings accounts, this means that you could earn more or less from your savings deposits, depending on whether the rate increases or decreases.
How interest is paid depends on your savings provider, but it’s usually paid annually. It’s always best to check the details of the savings account you’re applying for, as interest can also be paid quarterly, monthly or even daily. You’ll typically earn more from a savings account if interest is calculated more frequently.
If a financial service provider doesn’t use a standardised method of comparing interest rates, it can be difficult to compare savings accounts. Arguably, the most important thing you need to know is which interest rate a financial service provider is using, i.e. whether it’s the nominal interest rate or the AER. You should also find out how often interest is calculated and whether there are any administrative fees.
AER is typically used to compare the interest rates of savings accounts, as it clearly explains the overall interest you could earn. At Raisin Bank, we use the AER to advertise the interest rates of all savings accounts offered by our partner banks as we believe that it provides you with a clearer understanding of how profitable a savings account is.
You can use the table on our savings accounts page to compare and find the most competitive interest rates on savings accounts offered by our partner banks. The interest rate will depend on the bank, the deal they offer and the type of savings account.