Frequently Asked Questions

What is an Interest Rate?

Interest rate is the amount charged by lenders to borrowers for the use of money, expressed as a percentage of the principal, or original amount borrowed; it can also be described alternatively as the cost to borrow money. For instance, an 8% interest rate for borrowing $100 a year will obligate a person to pay $108 at year-end.

Simple vs. Compound Interest

Simple interest is calculated as a percentage of principal only, while compound interest is calculated as a percentage of the principal along with any accrued interest. As a result of this compounding behavior, interest earned by lenders subsequently earns interest over time. Most formal interest payment calculations today are compounded.

Uncontrollable Economic Factors that Affect Interest Rate

In most developed countries today, interest rates fluctuate mainly due to monetary policy set by central banks. The control of inflation is the major subject of monetary policies. Inflation is defined as the general increase in the price of goods and services and the fall in the purchasing power of money. Furthermore, supply and demand for credit play a significant role. When there exists a surplus of demand for money, lenders react by raising interest rates.

Controllable Factors that Determine Interest Rate

While economic conditions dictate baseline rates, individual choices matter heavily:

• Individual Credit Standing: The higher a borrower’s credit score, the more favorable the interest rate they may receive. Lenders charge higher rates to protect themselves from high-risk borrowers.
• Secured loans: Unsecured loans will carry higher interest rates than secured loans, mainly because there is no collateral involved.
• Loan specifics: Longer repayment terms or small down payments increase lender risk, resulting in higher interest rates.