How Do Interest Rates Actually Work?

They say it takes money to make money. The hard truth is that it also takes money to borrow money, though it kind of works in reverse.

The general idea behind loans is that a lender provides a sum of money in return for a promise that the borrower will pay that money (and some more) back within a specified period of time. So, any loan is a trade-off where you as the borrower say, “Having X dollars today is important enough to me that I’m willing to pay you back Y dollars.”
And that PLUS is pretty important, because the higher the interest rate, the more your X dollars is going to cost you. We refer to interest as the money that your money costs.

How Do Interest Rates Actually Work?

Let’s use a credit card as an example. Credit cards usually charge you interest based on what they call an annual percentage rate (APR). Credit card APRs vary widely, and often exceed 20%.

Because the “A” in APR stands for annual, the 20% figure applies to a balance that stayed on your card for a full year. But as you might know, credit card companies don’t just let you keep a balance for a year. They require you to make monthly payments. To  protect their interests and their interest, they take that 20% interest rate and divide it by 365 so there’s a tiny little chunk of interest that applies to every single day of the year. And they add that little tiny number onto your balance every day.

The problem is, it’s not so tiny when you factor it in over time. If you have a $1,000 balance on your credit card and a 20% APR, that amounts to $16.67 in interest that’s added onto your balance in a month. If you’re making the minimum payment on your credit card, which is often about 3% of the balance, your $30 payment would only reduce the balance by about $13.33 (Source: Bankrate.com payment calculator). And that’s just an example. If you have bad credit, you may get a higher APR, making paying off the balance even more difficult. 

Long story short, the money that your money costs gets a lot more substantial in a hurry. 

Short-Term Loans and Interest

The unfortunate news is that if you’re in the market for a short-term loan, you’re probably not going to get a great interest rate. Banks, credit cards, or even friends and family may be able to offer you better loan terms.

But if you do feel like a short-term loan meets your needs, the good news is that you do have a choice, and that choice matters.

Payday loans, for instance, generally aren’t very flexible. When the loan term is up, usually within two weeks, you need to pay back the entire amount. If you don’t have that money available, you can rollover the loan for another two weeks (or whatever your loan period is). That rollover will usually have an accompanying fee that won’t pay down the principal of your loan — it just postpones the day you have to pay it by.

Speaking of the loan period, that generally isn’t flexible either, which can be a problem. After all, if you had $500 to spare in two weeks, would you really need to borrow it today? Probably not.

When it comes to flexibility, many people find Spotloans offer more. Spotloans and payday loans are completely different. Spotloans are short-term installment loans, which means you pay back your loan over time. Every regular, scheduled payment helps pay down your loan, which means you can kiss those payday loan balloon payments goodbye.

Spotloans also provide you with a choice in how long you want to pay the loan back — anywhere from 3 to 10 months. Plus, you can pay your loan off early with no prepayment penalties.

Spotloan even works to make sure that customers who have previously paid off a Spotloan get a better rate on their next Spotloan. That could mean savings of up to $180 on an $800 Spotloan.

The Money Your Money Costs

Now, it’s clear that it takes money to borrow money. And not all situations are created equal. Sometimes, you need the money and it’s worth getting a less desirable interest rate. Sometimes it isn’t. Only you can make the decision.

But one thing is for certain: the circumstances that could lead to you needing a short-term loan won’t be flexible. You’ll want a short-term loan that is.