Interest is the fee, expressed in a certain amount, that the debtor has to pay to the creditor for the temporary transfer of goods and capital. The interest rate is the interest amount expressed in percent per time interval, usually calculated per year.
Anyone who pays rent for the use of a thing is actually paying an interest. Interest is therefore not only paid in the context of lending money. Debit interest is differentiated from credit interest, depending on whether someone pays interest or receives interest.
Borrowers receive capital and pay a fee for it
In their view, the interest is a borrowing rate. The lender, the bank, leaves the borrower with a certain amount of money for a certain time.
From the bank’s perspective, the lending rate is a credit rate. Investors, for example, investors in overnight money, give the bank money and receive a credit interest, which represents the bank’s borrowing rate.
This is about the interest rates that borrowers who want to borrow have to deal with. The borrowing rate forms the basis.
The legislature has also introduced additional interest types, primarily to protect consumers, which modify the pure borrowing rate.
Borrowing rate and bound borrowing rate
Legislators themselves provide the definition of the term “borrowing rate” and “bound borrowing rate” in the context of loan contracts in section 489 (5) of the German Civil Code:
The borrowing rate is the tied or changing periodic percentage that is applied to the loan taken out each year. The borrowing rate is bound if a borrowing rate or several borrowing rates have been agreed for the entire contract term, which is expressed as a fixed percentage. If no borrowing rate has been agreed for the entire contract period, the borrowing rate is only binding for those periods for which it is determined by a fixed percentage.
According to this, the bound borrowing rate is a fixed rate either for the entire term of a loan or for certain periods during the term.
In the case of classic installment loans, the borrowing rate is generally tied over the entire term. Loans with a fixed interest rate offers planning security over the entire term.
Before the basic law reform on consumer loans, the term nominal interest was common. The borrowing rate and nominal rate are the same as far as the interest rate that a borrower has to pay to the lender.
Variable borrowing rate
If a variable borrowing rate is agreed upon, the fee for the transfer of use of capital (for the loan) can change in accordance with the regulations made. Variable interest rates pose the risk of interest rate hikes for borrowers. On the other hand, the initial floating borrowing rates are typically lower than the tied interest rates applicable at the same time.
In addition, loan contracts with a variable interest rate can be terminated at any time with a notice period of three months. This regulation is particularly interesting for real estate loans with a variable borrowing rate.
Overdraft facilities and master loans are loans with a variable borrowing rate. Theoretically, interest rates can change daily.
In practice, however, certain regulations regarding interest rate change intervals are often made. For example, it is agreed that interest rates can be adjusted to a specific market interest rate every three months.
Apart from variable interest rates, overdrafts and framework loans have another special feature. In principle, no specific term is agreed upon. Interest-only accrues on the amount of credit drawn.
In principle, the interest on overdraft facilities and other credit lines are contractually bound to a certain market interest rate, the reference interest rate. Otherwise, the lender could raise interest rates at any time.