What types of interest rates are there?
Generally speaking, there are two types of interest rates:
- Fixed interest rates
- Variable interest rates fluctuate in line with a base rate which, typically, shifts in reaction to market factors. Base rates may also change in order to stimulate the market to shift in one direction or another. You may pay 11.85% interest for a period, then 9.5% for another.
Variable interest rates are comprised of two parts:
- Your personal margin (expressed as a percentage) which is a reflection of your financial health or whatever criteria a lender puts in place to assess risk on the money they lend. This portion of your interest doesn’t change over time, it’s the base rate that fluctuates.
- A base rate such as Prime, SOFR, MCLR or others. Base rates can be set by independent groups, governmental direction, a consortium of banks, or any other body mandated to set and adjust the relevant base rate. Base rates may change daily, monthly, or just as dictated by market changes.
There isn’t a single equation used to determine base rates. Instead, each one is calculated according to a different set of standards - and by different institutions.
In 2017, the FCA announced that LIBOR (London Interbank Offered Rate), our base rate, will be phased out, as the sustainability of this base rate is uncertain. Based on research and the FCA’s recommendation we’ll be changing our base rate to SOFR (secured overnight financing rate). From 4 Jan 2022, we will use 3-month CME Term SOFR for our loans.
Who sets up base rates?
- Commercial banks linked to central banks; examples include SELIC in Brazil and MCLR in India,
- Non-banking financial institutions (NBFCs), or
- Independent financial institutions, such as SOFR in the US and UK, Euribor in the EU, and Prime in the US and Japan.
Commercial banks and non-banking financial institution rates might change according to market factors or national fiscal policies. Prime is typically set at three percentage points above the federal funds rate.
How often do variable interest rates change?
It really depends.
Some rates change when they work against a country’s monetary goals while others change daily. MCLR is reviewed monthly and Prime changes periodically, typically in line with the federal fund rates.
Prodigy Finance loans use a benchmark (variable base rate). There are two ways to confirm this variable base rate being applied to your loan: