What Is An Interest Rate?

 

Nowadays, much of the economy is based upon the concept of making profit by loaning money to other people.  This profit comes in the form of interest.  Interest on a sum of money is determined by establishing a rate of interest.

 

You may be wondering, “What is an interest rate?”

 

An interest rate is the percentage of an amount of money charged for its use.  This rate can vary widely depending on what purpose the money is being lent out and by whom.  For example, a person buying a home can get a mortgage loan with an interest rate around 3 ½ percent; however, someone who is applying for a credit card may find their rate of interest charged to them every time they make a purchase to be upwards of 20 percent.

 

There are two general types of interest rates.  There is a fixed rate and a variable rate.  The fixed rate is set at a certain amount and does not change during the period of the loan (unless the debtor defaults on the loan).  The variable interest rate can change while the loan is being repaid.  Some interest rates are tied to fluctuating global financial markets and increase or decrease as the market changes.  Other variable interest rates will change based upon a predetermined schedule.

 

An example of what is an interest rate and how it works can be seen by assuming you borrowed a thousand dollars from your bank and agreed to pay it back over a year’s period of time.  The bank agrees to loan you the money and charges you an annual interest rate of 10%.  Ten percent of one thousand dollars is one hundred dollars.  This one hundred bucks is bank’s return, or profit, for loaning you the money, and your total loan would be $1,100 and your monthly payments would be $91.66.

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