Tipo de Interés... ¿Quién es ese tipo?

Today we're going to talk about a type that influences many aspects of our lives, Interest Rate. In reality, there are several types, not just one, that we need to analyze. We'll see what they consist of and what each of them affects.

Official Interest Rate:

Usually, it's Central Banks that decide what the official interest rate is, taking into account various economic indicators. Thus:

- During crises, the tendency will be to lower interest rates to stimulate the economy. By lowering the price of money:

  * Companies will find it easier and cheaper to finance themselves.

  * Consumers will pay less for their loans or mortgages while their savings will yield less.

  * Governments benefit when issuing bonds or obligations because fixed-income securities increase in value since older bonds become more attractive and investors are less willing to sell their bonds.

- During booms, the tendency will be to raise interest rates to cool down the economy and prevent the emergence of bubbles. Money becomes more expensive, leading to:

  * Encouraging saving among consumers since any product offering a fixed return linked to interest rates becomes more attractive.

  * Companies seeking financing with variable interest rates will face higher costs. Investment decreases.

  * Bonds and obligations decline as newly issued fixed-income securities become more attractive than current ones due to a higher coupon rate, leading to investors selling off their bonds and consequent price drops.

As we can see, the interest rate directly affects consumption, investment, and trade. Therefore, Central Banks take into account the economic situation when setting or modifying interest rates.

The interest rate in Spain is set by the European Central Bank. The ECB sets the official price of money for Europe; it's the rate at which it lends money to banks (refinancing rate). Other magnitudes are derived from this, such as the Euribor, which is the rate at which banks lend to each other. In most mortgages, the reference rate is the Euribor.

The Governing Council of the ECB, faced with economic recession, gradually lowered interest rates until reaching 0%, which is the current rate.

On the other hand, the average Euribor in February 2020 was -0.279%.

Alongside official benchmark rates, there are other types of interest rates classified as legal rates because they are defined by laws.

Legal Interest Rate:

It's set annually by the General State Budget Law. It serves as a reference for legal norms or when formalizing agreements in contracts. It will also be the one established as compensation for damages when a debtor fails to pay and no rate has been previously agreed upon between the parties (2020, annual rate of 3%).

Default Interest Rate:

This is what we would have to pay for being late in a payment commitment.

It arises as a measure to combat late payments in commercial transactions, establishing a rate to apply in case no rate has been agreed upon in the contract (Law 3/2004). The Ministry of Economy, Industry, and Competitiveness will publish this interest rate semi-annually in the Official State Gazette (2020 - 1st semester, annual rate of 8%).

Article 1,108 of the Civil Code, "If the obligation consists of paying a sum of money, and the debtor incurs in default, the compensation for damages and losses, in the absence of any agreement to the contrary, shall consist of the payment of the agreed interest, and in the absence of an agreement, in the legal interest established for this purpose."

 For Tax purposes, it will be the legal interest rate increased by 25%, unless the State Budget Law establishes a different rate.

Usury Interest Rate: 

 When a default interest rate is disproportionate, it's considered Usurious.

Financial Interests:

- Financial default interests: Established as a penalty for failure to meet agreed-upon deadlines, for example, paying loan amortization installments late as per the contract.

- Remunerative Interests: Basically, these are the interests that we have to pay for a loan (we borrow money) or that we will receive for a deposit (we lend our money). That is, interests agreed upon and reflected in a contract that are generated as compensation for the transfer of financial capital.

In INVERSA, for example, both circumstances occur: on one hand, there are Investors who earn interest on their investment, and on the other hand, there are Companies that will have to pay interest in exchange for the financing of their invoices.

They are usually expressed as percentages and linked to a period of one year, annual interest rate. If the financing or investment period is shorter, the equivalent rate must be calculated. For example, if we talk about an annual rate of 4% but the financing period is six months, what would be paid or received is 2%, three months would be 1%, one month would be 0.33%, etc.

This must be taken into account when comparing financial products from different entities.

It's common to refer everything to annual rates, but not always the case. You may have two quotes, one at 4% and another at 3%; apparently, the second one is better and it would be if both are referred to the same time period, but what if it's not.

Let's suppose that:

The 4% is annual, that is, twelve months.

The 3% is financing for six months.

We need to equalize the months, and we already saw that a 4% annual rate is equivalent to a 2% semi-annual rate, which is cheaper than the second option.

We always have to compare in equal time periods whether it's interest to pay or interest to earn.

In connection with this, it's useful to understand the difference between the Nominal Interest Rate (TIN) and the Annual Equivalent Rate (TAE). The TIN is the interest that will be charged or paid. It can be daily, weekly, monthly, quarterly, semi-annually, or annually; although the most common is monthly. The TAE is the interest that shows the effective cost or return annually of the operation for the user. It incorporates the nominal interest rate (TIN) plus some fees and expenses associated with the contract. Since the nominal interest rate may be in different time formats when comparing, it's advisable to look at the annual equivalent rate.In the case of a deposit, to know the real profitability, it's necessary to discount inflation from the TIN and TAE, to know how much our savings have actually increased in terms of purchasing power.Finally, we'll talk about a type that should never exist, the Usury Interest.