What is an Interest Rate?
An interest rate is a percentage charged on the total amount one borrows or saves.
If you’re a borrower, an interest rate is the amount you are charged for borrowing money – a percentage of the total amount of the loan. You can borrow money to buy something today and pay for it later.
If you’re a saver, it’s the same except that the interest is paid to you because banks pay to use your money.
How lenders decide on interest rates?
Lenders usually have a reference rate, which is the benchmark rate. Interest rates on all loans are linked to it. For example, a lender’s benchmark rate is 5%. It may offer an auto loan 2% higher than the benchmark rate, which would be 7%. Similarly, it may provide personal loans at 4-5 higher than the benchmark rate, i.e. @ 10%.
In India, the RBI (central bank of India) has focused on making the benchmark rate transparent. Over a period, it has introduced different ways to calculate the benchmark rates. Earlier, banks had prime lending rate (PLR), then came the base rate and later MCLR or marginal cost of funds-based lending rate.