Interest rates are used to compute for the amount of interest or fee to be levied for borrowed money.

There are three basic types of interest rates: simple, compound, and amortized.

Simple interest rates

These are calculated based only on the principal amount so that the interest paid for $100 with an interest rate of 10% per annum is $10. If the loan is paid before the agreed to period, in this case 12 months, then the interest is calculated based on the period already elapsed. For example, if the loan is paid by the 6th month, then the interest levied will simply be $5.

Compound interest rates

This type of interest is computed based on the principal and the accrued interest. For example, if the interest rate for a compounding loan is %2 per month, that means that a $100 loan will balloon to $162.52 by the 6th month if no payments are made. This means that a total of $62.52 is paid in interest; a pretty stiff figure compared to simple interest. Albert Einstein once said that “The most powerful force in the universe is compound interest.” Hence, you’d better make sure that compound interest works for you by investing in funds with compounding interest and avoiding debts (i.e. credit card debts) that apply compound interest rates.

Amortized interest rates

Amortized interest rates work the opposite way that compound interest does. Though the interest rate stays the same, the total interest paid gets smaller each time the borrower gives a partial payment, since the interest is computed based on the remaining loan amount.