Interest rate

What it means

An interest rate is the price of borrowing money, expressed as a percentage of the amount owed over a period, usually a year. For the borrower it determines how much they pay on top of the principal; for the lender, what return the money lent brings.

The rate may be fixed, fixed for a certain period, or variable. For business loans a variable rate usually consists of a reference rate, such as EURIBOR, plus the bank’s margin reflecting the client’s risk. For consumer credit, the total cost is also expressed by the APR.

Interest rates in the euro area are driven by the European Central Bank’s key rates. Changes feed into variable-rate loans and, for new loans, into fixed rates too.

How it works in practice

When choosing a loan we compare with the client not only the rate but also fees, required security and conditions. For long-term investments we consider fixing the rate, which gives predictable repayments, although it is usually more expensive than a variable rate.

For loans between related parties, such as from a shareholder to the company, the interest rate must be at arm’s length. We set it by comparing bank offers for a similar loan and document it, because the tax office checks it in audits.

In cash flow planning we model the effect of rising rates on variable-rate repayments. For a highly leveraged company, even a rise of one or two percentage points can significantly change its ability to repay.

What to watch out for

A low rate with high fees or compulsory products can cost more overall than a higher rate without them. What counts is the total cost of the loan over its whole term, not just the headline figure.

The interest rate differs from the rate of late-payment interest, which applies when a debtor does not pay on time. That is usually much higher, and in business dealings its level is set by law unless the parties agree otherwise.