Interest Rate

AAA

DEFINITION of 'Interest Rate'

The amount charged, expressed as a percentage of principal, by a lender to a borrower for the use of assets. Interest rates are typically noted on an annual basis, known as the annual percentage rate (APR). The assets borrowed could include, cash, consumer goods, large assets, such as a vehicle or building. Interest is essentially a rental, or leasing charge to the borrower, for the asset's use. In the case of a large asset, like a vehicle or building, the interest rate is sometimes known as the "lease rate". When the borrower is a low-risk party, they will usually be charged a low interest rate; if the borrower is considered high risk, the interest rate that they are charged will be higher.

INVESTOPEDIA EXPLAINS 'Interest Rate'

Interest is charged by lenders as compensation for the loss of the asset's use. In the case of lending money, the lender could have invested the funds instead of lending them out. With lending a large asset, the lender may have been able to generate income from the asset should they have decided to use it themselves.

Using the simple interest formula:

Simple Interest = P (principal) x I (annual interest rate) x N (years)

Borrowing $1,000 at a 6% annual interest rate for 8 months means that you would owe $40 in interest (1000 x 6% x 8/12).

Using the compound interest formula:

Compound Interest = P (principal) x [ ( 1 + I(interest rate) N (months) ) - 1 ]

Borrowing $1,000 at a 6% annual interest rate for 8 months means that you would owe $40.70.

The interest owed when compounding is taken into consideration is higher, because interest has been charged monthly on the principal + accrued interest from the previous months. For shorter time frames, the calculation of interest will be similar for both methods. As the lending time increases, though, the disparity between the two types of interest calculations grows.

VIDEO

RELATED TERMS
  1. Nominal Interest Rate

    The interest rate before taking inflation into account. The equation ...
  2. Lock Period

    A number of days, often 30 or 60, during which the interest rate ...
  3. Real Interest Rate

    An interest rate that has been adjusted to remove the effects ...
  4. Ben Bernanke

    The chairman of the board of governors of the U.S. Federal Reserve. ...
  5. Alan Greenspan

    The former chairman of the Board of Governors of the Federal ...
  6. Fixed Interest Rate

    An interest rate on a liability, such as a loan or mortgage, ...
Related Articles
  1. Credit & Loans

    Does a cash advance hurt my credit score?

    Find out if a cash advance will hurt your credit score and how your credit report and requests for new credit can be affected by a cash advance,
  2. Credit & Loans

    How does interest work on a cash advance from my credit card?

    Find out how cash advances and regular credit card purchases are treated differently and what it means for your financial bottom line.
  3. Bonds & Fixed Income

    What methods can the government use to control inflation?

    Find out what inflation is, what a government can do to control it, and how the results of those actions help or hurt the economy overall.
  4. Credit & Loans

    Can debt collectors add fees to my debt?

    Find out when a debt collector is legally allowed to charge interest and fees on a past-due debt and if a debtor can contest these fees.
  5. Forex Education

    Why doesn't England use the euro?

    Understand why the United Kingdom has opted to not join the eurozone in adopting the euro over the pound sterling as its predominant currency.
  6. Economics

    Forces Behind Interest Rates

    Get a deeper understanding of the importance of interest rates and what makes them change.
  7. Economics

    How Interest Rates Affect The Housing Market

    Understand how rate changes can affect home prices, and learn how you can keep up.
  8. Investing Basics

    How Interest Rates Affect The Stock Market

    Whether you're buying lunch, a home or a stock, you're influenced by interest rates.
  9. Investing Basics

    What Investors Should Know About Interest Rates

    Understanding interest rates helps you answer the fundamental question of where to put your money.
  10. Credit & Loans

    House Price Vs. Interest Rate: Which Is More Important?

    Deciding which factor is more important can make a difference in monthly payments, ability to move and Homowners Association fees.

You May Also Like

Hot Definitions
  1. SWOT Analysis

    A tool that identifies the strengths, weaknesses, opportunities and threats of an organization. Specifically, SWOT is a basic, ...
  2. Simple Interest

    A quick method of calculating the interest charge on a loan. Simple interest is determined by multiplying the interest rate ...
  3. Special Administrative Region - SAR

    Unique geographical areas with a high degree of autonomy set up by the People's Republic of China. The Special Administrative ...
  4. Annual Percentage Rate - APR

    The annual rate that is charged for borrowing (or made by investing), expressed as a single percentage number that represents ...
  5. Free Carrier - FCA

    A trade term requiring the seller to deliver goods to a named airport, terminal, or other place where the carrier operates. ...
  6. Law Of Supply And Demand

    A theory explaining the interaction between the supply of a resource and the demand for that resource. The law of supply ...
Trading Center