The interest rate charged by the person or business that lends the money is determined mostly by the risk they take on. The less risk they take, the lower the interest will be that they charge.
The interest rate a lender charges the borrower is proportional to the risk they take on. Interest rates are added onto the amount of money you borrow. This rate is added on every month. When repaying your loan you will need to cover both the actual loan amount and the interest charged.
The South African NCR has placed a ceiling on lenders. This prevents them from charging more than a certain amount of interest per year depending on what loan a person applies for. For example:
Personal loan: 32%
Pay Day loan: 60%
The interest charged is added onto your outstanding amount. It is calculated per annum but payable on every instalment (monthly).
Fixed Interest rate
A fixed interest rate is when the lender and borrower decide to charge a particular fixed interest rate on the loan regardless of the movements of external interest rates. This will help the borrower budget their cash flow. It can either work for you, or against you, for example if external forces might have resulted in your payment being lower. Once you and the lender have decided on the interest rate that will be charged, it will not change throughout the duration of your loan.
Compounded interest is when interest is charged on top of interest. Let’s use a simple example. If you borrow R100 and the interest charged after Month 1 amounts to R10. The interest charged and payable for Month 2 will be worked from R110 (100+10=110) and not R100 like it was for the first month. This compounding of the interest rate can result in a person being charged considerably more than what they would like. The borrower needs to ensure they minimise the amount of compounded interest charged. This is usually done through paying on agreed upon time periods and amounts payable.