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Interest rate, what is it and how is it determined, New information that will add up to you!

What is the interest rate?

The interest rate is the amount that the lender sets to the borrower and is a percentage of the principal or amount borrowed.

The interest rate on a loan is often determined on an annual basis known as the Annual Percentage Rate (APR). In simple terms, the interest rate is the amount charged by the lender on the borrower’s principal for the use of the assets.

An interest rate can also be applied to the amount earned at a bank or credit union from a savings account or certificate of deposit (CD).

The term interest rate can also be applied to the amount earned at a bank or credit union from a deposit account.

Annual Percentage Yield (APY) refers to the interest earned on these deposit accounts.

Most mortgages use relatively small interest. However, some loans use compound interest, which is applied to the principal and to the interest accumulated for prior periods.

We conclude from the foregoing that…

Interest is a fee charged to the borrower for the use of the asset. Borrowed assets may include cash, consumer goods, vehicles, and property. So we can think of the interest rate as the “cost of money” as higher interest rates make it more expensive to borrow the same amount of money.

People borrow money to buy homes, finance projects, or launch or fund businesses. Companies obtain loans to finance capital projects and expand their operations by purchasing fixed and long-term assets such as land, buildings and machinery. The borrowed money is repaid either in a lump sum on a predetermined date or in periodic installments.

The difference between the total repayment amount and the original loan is the interest charged.

What are the indicators for setting the interest rate for lenders?

When a borrower is deemed to be low risk by the lender, the borrower will usually be charged a lower interest rate. If the borrower is considered a high-risk investment, the interest rate charged will be higher, resulting in a higher cost loan.

Risk is usually assessed when a lender looks at a potential borrower’s credit score, which is why it is important to have an excellent score if you want to qualify for the best loans.

Types of interest rate:

  • Simple interest rate

Simple interest is calculated using the simple annual interest formula, which is:

Simple interest = Interest rate X Principal X Duration

  • compound interest rate

Some lenders prefer the compound interest method, which means the borrower pays more interest. Compound interest is applied to both principal as well as interest accumulated during previous periods. The bank assumes that at the end of the first year the borrower owes principal plus interest for that year.

The bank also assumes that at the end of the second year, the borrower owes the principal plus the interest for the first year plus the interest for the first year.

The interest payable at compounding is higher than the interest payable using the simple interest method.

How are interest rates determined?

The interest rate charged by banks is determined by a number of factors such as the state of the economy, where the central bank of a country sets the interest rate, which is used by each bank to determine the range of annual interest rate that it offers. When the central bank sets interest rates at a high level, the cost of loans goes up.

When the cost of loans is high, it discourages people from borrowing and discourages consumer demand, and interest rates also rise with inflation.

With high inflation, companies also have limited access to capital financing through loans and equity, which leads to economic downturn.

Economies are often stimulated during periods of low interest rates because borrowers can get loans at cheap rates.

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