Interest is the charge for borrowing money. Interest expense or revenue is often expressed as a dollar amount, while the interest rate used to calculate interest is typically described as an annual percentage rate (APR). It's also the amount of money a lender or financial institution receives for lending out money.

Interest can also refer to the amount of ownership a stockhold𝐆er has in a company, usually expressed as a percentage.

Understanding Interest

Interest compensates one party for incurring risk and sacrificing the opportunity to use funds while penalizing another party for using someone else's funds. The person temporarily parting ways with their money is entitled to compensation, and the person temporarily using those funds is often required to pay this compensation.

When you leave money in your 澳洲幸运5官方开奖结果体彩网:savings account, your account is credi💯ted interest. This is because the bank uses your mo🃏ney and loans it out to other clients, resulting in you earning interest revenue.

The amount of interest a person must pay is often tied to their creditworthinessꦬ, the length of the loan, or the nature of the loan. All else being equal, interest and interest rates are higher when there is greater risk; as the lender faces a greater risk of the borrower being unable to make t🌳heir payments, the lender may charge more interest to incentivize them to make the loan.

History of Interest Rates

The concept of interest—the cost of borrowing money—is commonplace today. However, the acceptability of interest only began during the Renaissance💙.

Interest is an ancient practice, but social norms from ancient Mediterranean and Middle Eastern civilizations to Medieval Europe regarded charging interest on loans as a sin or usury. Before Christianity, the Greeks and Romans understood that making money off money itself was unnatural, as Aristotle argued in his Politics. Aristotle separated two kinds of moneymaking, which are crucial for almost two mꩲillennia that followed him across Europe and the Middle East:

• Proper economic relations (oikonomikē): These belong to the needs of household management (English gets the word "economics" from the Greek term). Wealth is a means toward another end (food, shelter, property, the good life, etc.).
• Unnatural love of money (chrēmatistikē): Here, wealth acquisition becomes its own end through trade and using money to make more money. Aristotle viewed this form of moneymaking as unnatural and harmful to those who practiced it. In his Nicomachean Ethics, he suggested it was a life so foolhardy that it deserved no serious discussion when describing flourishing lives. He was particularly critical of usury (lending money at interest), which he saw as the most unnatural form of chrēmatistikē. Importantly, usury meant any interest earned, not excessive interest, as is meant today.

Once these distinctions were carried through Islam and Catholic Scholasticism, usury was deemed a sin, unworthy of those who had their souls directed toward that which is eternal—not the money-grubbing and fallen nature of this world. Loans were just to make money on money. And were someone in need, what kind of person would only give charity at a price? Lenders were seen as profiting from others' misfortunes.

The moral dubiousness of charging interest on loans began to fade during the Renaissance, first in Italy and then slowly as the seeds of later industrialization began to sprout. People started borrowing money to grow businesses and improve their economic standing. Growing markets and relative economic mobi♐lity made loans more common and charging interest more acceptable. During this time, money began to be considered a commodity, and the opportunity cost of lending it was seen as worth charging for.

Political philosophers in the 18th and 19th centuries, including Adam Smith, Frédéric Bastiat, and Carl Menger, elucidated the economic theory behind charging inter𝓡est rates for lent money. They argued that interest was a legitimate compensation for the risk and opportunity cost associated with lending.

Islam still bans the charging of interest, known as riba (رِبَا) in Arabic. Instead, Islamic banking practices often involve profit and loss-sharing arrangements. This approach to finance, which avoids traditional interest, is central to understand for anyone involved in business and finance in the Islamic world.

Today, interest rates are applied to various financial products, including mortgages, credit cards, car loans, and personal loans. Central banks, like the U.S. Federal Reserve, use interest rates as a vital tool for monetary policy. By adjusting the federal funds rate, it influences broader economic conditions.

In recent years, interest rates have seen significant fluctuations. Rates started to fall in 2019 and were brought to near zero in 2020 in response to the COVID-19 pandemic. However, the U.S. soon raised interest rates to combat inflation. This changed in 2024, as hiring slowed and inflation abated. In September 2024, the Fed cut its federal funds rate by 0.50%.

Formula and Calculation of Interest

In its𒆙 most basic form, interest is calculated by multiplying the outstanding principal by the in♑terest rate.

Interest = Interest Rate × Principal or Balance

The more complex aspect of calculating interest is often determining the correct interest rate. The interest rate is often expressed as a percentage and is usually designated as the APR. However, 澳洲幸运5官方开奖结果体彩网:calculating the APR often does not reflect any effects of 澳洲幸运5官方开奖结果体彩网:compounding. Instead, the effectꦺive annual rate is used to express the actual rate of interest to be paid.

Often, an annual rate must be converted to calculate the applicable interest earned in a given period. For example, if a savings account is to pay 3% interest on the average balance, the account may award 0.25% (3% / 12 mont🌠hs) each month.

The applicable interest rate is then multiplied against the outstanding amount of money related to the interest assessme💞nt. For loans, this is the outstanding principal balance. For savings this is often the average balance of savings for a given period.

In either case, the amount of interest assessed each period will likely change. For loans, borrowers will have likely made payments that reduce the principal balance, resulting in lower interest. For savers, general activity (including the addition of last month's interest) often changes the applicable balance.

Simple Interest vs. Compound Interest

Two main types of interest can be applied to loans—simple and compound. Simple interest is a set rate on the principal originally lent to the borrower that the borrower has to pay for the ability to use the m🍰oney. Compound interest is interest on both the principal and the compounding interest paid on that loan. The latter of the two types of interest is the most common.

For o🎐bvious reasons, individuals attempting to earn interest prefer compound interest agreements. This agreement results in interest being earned on interest and results in more total earnings. Savings accounts with banks often earn compound interest; any prior interest earned on your savings is deposited into your account, and this new balance is what earns interest in future periods.

Meanwhile, compound interest is extremely concerning for borrowers especially if their accrued compound interest is 澳洲幸运5官方开奖结果体彩网:capitalized into their outstan𝓡ding principal. This means the borrower's monthly payment will actually increase because of now having a greater lo🍬an than what they started with.

Common Uses of Interest

There are countless ways a person can charge or be charged interest. Below are som♓e common examples of where interest may be earned by one party and paid by another.

• Credit cards: Among the methods of borrowing money that incur the highest amount of interest, 澳洲幸运5官方开奖结果体彩网:credit cards are known for having a high APR. Consumers may make minimum monthly installment payments; in return, interest expense may accumulate and is earned by the credit card providers/underlying financial institutions.
• Mortgages: Among the longest-term loans, mortgages often incur interest over the entirety of their potential 30-year term. Though interest may be assessed as a fixed or variable rate, it is theoretically reduced over time as the borrower pays down the original loan principal amount.
• Auto loans: An example of a shorter-term loan, auto loans are often awarded for terms up to six years. Interest is often charged as a fixed rate, and the dealership extending credit may have an in-house financing department that collects the interest revenue.
• Student loans: During COVID-19, 澳洲幸运5官方开奖结果体彩网:student loan payments were paused, and prevailing loan rates were dropped to 0%. This meant that for a while, all loans incurred no interest assessments.
• Savings accounts: Often a positive type of interest for most consumers, savings accounts earn monthly interest assessments. Also called dividends, these deposits are automatically credited to your account.
• Invoices: Though many companies may assess a late fee, some companies choose to assess an interest charge on outstanding and late invoices. The idea is since the late payer is technically borrowing money from the invoice holder, the invoice holder is due interest.

Advantages and Disadvantages of Paying Interest

Imagine a situation where you need reliable transportation to get to work. There is no public transit system, you do not own a car, work is far away, and you can't afford to buy an entire car outright. The largest advantage of paying interest is its relatively low expense compared with alternatives.

Paying interest also means a payer is holding debt, building their credit history, and potentially effectively using leverage. For example, real estate developers often borrow money to construct and rent buildings. If the rate of return on the building is greater than the interest rate the🐻y are charged, the company is suᩚᩚᩚᩚᩚᩚ⁤⁤⁤⁤ᩚ⁤⁤⁤⁤ᩚ⁤⁤⁤⁤ᩚ𒀱ᩚᩚᩚccessfully using someone else's money to make money for themselves.

On the downside, interest is a recurring cash expense. Payers are often contractually obligated to pay interest, and monthly payments are typically applied to interest assessments before paying down 💝the principal. Consumers may find interest assessments overwhelming. In addition, having too many loans and monthly payments that are too high may restrict a borrower from being able to take out more credit.

Advantages and Disadvantages of Collecting Inter🅘est

A strategy for many investors is to collect interest. Often a fixed amount, interest often provides positive cash flow that is a reliable source of income depending on the creditworthin♌ess of the person borrowing the money. Instead of having capital sitting around and not being used, lending money to others is a more efficient way of deploying capital, especially in the short term when the lender may need that money for a specific reason in the longer term.

Interest is also touted as one of the simplest forms of 澳洲幸运5官方开奖结果体彩网:passive income. Loans may require little to no administration or maintenance after signing the agreement. L๊enders may simply collecꦆt interest and principal payments.

There are some downsides to collecting interest. First, 澳洲幸运5官方开奖结果体彩网:interest revenue is taxable; even a tiny amount may push a taxpayer into a higher tax bracket. Next, because you are collecting interes𓃲t, this means you are allowing someone else to use your capital. Though you may be satisfied collecting interest, there will often be greater earning potential had you utilized the capital yourself.

Also, collecting interest may have philosophical opponents. Consider student loan debt assessments. While some say interest rates near 10% are reasonable for the amount of risk, these lenders are incurring, others claim these rates🅰 are predatory to young adults and should not be assessed.

Interest and Macroeconomics

A low interest rate environment is intended to stimulate economic growth so that it is cheaper to borrow money. This is beneficial for those who are shopping for new homes simply because it lowers their monthly payment and means more affordable costs. When the 澳洲幸运5官方开奖结果体彩网:Federal Reserve lowers rates, it means more money in consumers' pockets 澳洲幸运5官方开奖结果体彩网:to spend in other areas and more large purchases of items, such as houses. Banks also benefi🔜t from this environment because they can lend more money.

However, low interest rates aren't always ideal. A high interest rate typically tells us that the economy is strong and doing well. In a low interest rate environment, there are lower returns on investments and in savings accounts, and, of course, an increase in debt, which could mean a higher chance of default when rates go back up.

In response to COVID-19, the Federal Reserve began enacting monetary policy as early as March 2020. Then, as the pandemic eased, the Federal Reserve began raising the federal funds rate. As this federal funds rate influences the interest rate on many other types of loans, borrowers soon found it to be more expensive to incur debt. In September 2024, the Fed reversed♐ track after seei🧸ng inflation ease and hiring slow, cutting the fed funds rate by 0.50%. This cut rates for consumers borrowing on everything from mortgages to cars to credit cards.

The Bottom Line

Interest is critical for capitalist economies. By allowing individuals to borrow and lend money, society has greater economic prosperity by encouraging spending. As a result, capital likely doesn't sit around idly; it is borrowed by some and lent by others. Through the payment of interest, individuals are encouraged to always put money to use.