How is interest on a loan calculated?

When a bank or finance house lends out money they will usually use a reference rate, which in the United Kingdom will usually be LIBOR (London Interbank Offered Rate) or EURIBOR (Euro Interbank Offer Rate) and this will usually be referred to as the ‘base rate’. The margin that the financier or bank makes is the rate charged on top of this. The margin on top can be fixed or floating. A straight forward mortgage borrowing could be fixed (base and margin rate) for a number of years, but then may float. As an example, if the base rate changes it will mean the cost of borrowing also changes after the fixed period.

Complicated calculations on larger facilities

Larger structured finance deals or corporate loans which are usually for a longer tenor, sometimes have a variation from the standard fixed rate. Facilities relating to blue chip companies may have a base rate that is assigned to their facility, but the margin on top will relate to a reference grid appended to the back of the facility. The reference grid will attribute certain margin figures to ratings and will be applied at certain periods through the life of the facility. As an example, a large ratings agency may rate a company every quarter. The loan may therefore be calculated at that period in time on the basis of that rating. In re-calculating the amount to pay, the company would look at the formula for calculation of the facility and this will usually be worked out by looking at the applicable base rate and the amount in the relevant grid that applies to the rating that the company has been given.

What happens if the company is not rated?

In the event that the company does not have a rating e.g. not a blue chip/listed company, then a leverage grid can be used. The grid is appended to the facility and when the loan is re-calculated at the period agreed in the facility, it will use the reference rate as agreed but the grid will have calculations of interest charges next to agreed leverage ratios. The ratio is agreed in the borrowing documentation and as an example can be the ratio of (net) debt at the relevant testing date to EDITDA for the period of x amount of time preceding the testing date. Obviously time periods and types of ratio can be agreed.

How is interest calculated in trade finance?

As with the above, interest on a trade finance deal can vary, depending on the status of the company (be it a blue chip or SME). All of our trade financiers offer very competitive interest rates, which are calculated based on the risk of the transaction. There can be fixed or floating rates depending on the duration and nature of the trade finance deal. At Trade Finance Global, to assess the risk of a trade finance deal, our team will often ask for cash flow forecasts, historic accounts, and balance sheets of your business to assess the risk of the transaction and ensure the most appropriate funder deals with your query. Find out more about trade finance here or get in touch with our team if your business is looking to find out about the interest rates relating to your trade finance facility.

Summary
How is interest on a loan calculated?
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How is interest on a loan calculated?
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This article explains the different types of interest and some of the ways financiers calculate interest on both small and large trade finance deals.
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