Interest Rate

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 What is an Interest Rate?

An interest rate refers to the amount charged by a lender to a borrower for any form of debt given, expressed as a percentage of the principal. 

Interest rates are the price you pay to borrow money, or, on the flip side, the payment you receive when you lend money.

The asset borrowed can be in the form of cash, large assets such as vehicle or building, or just consumer goods. In the case of larger assets, the interest rate is commonly referred to as the “lease rate.”



Interest rates are directly proportional to the amount of risk associated with the borrower. Interest is charged as compensation for the loss caused to the asset due to use. In the case of lending money, the lender could’ve invested the money in some other venture instead of giving it as a loan.

 In the case of lending assets, the lender could’ve generated income by making use of the asset himself. Thus, in return for these lost opportunities, interest rates are applied as compensation.

The annual interest rate refers to the rate that is applied over a period of one year. Interest rates can be applied over different periods, such as monthly, quarterly, or bi-annually. However, in most cases, interest rates are annualized.

Interest rate can also refer to the rate paid by the bank to its clients for keeping deposits in the bank.

Interest Rate Example:

If you take out a $300,000 mortgage from the bank and the loan agreement stipulates that the interest rate on the loan is 4%, this means that you will have to pay the bank the original loan amount of $300,000 + (4% x $300,000) = $300,000 + $12,000 = $312,000

Effect of Interest Rate:

The interest rate effect is the change in borrowing and spending behaviors in the aftermath of an interest rate adjustment.



As a general rule, when interest rates are set by a nation’s central bank, consumer banks extend similar interest rates to their clientele (while adding in additional interest that serves as their profit margin).


When a central bank lowers the interest rate, consumer banks lower their own rates, and this typically prompts businesses and individuals to borrow more money. After all, the cost of borrowing is “cheaper” if the borrower owes less in monthly interest payments.

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