Interest Rates and Why They Apply

Interest rate is that extra fee that you are charged for borrowing whether if it is money, or for the use of assets like consumer goods, vehicles or property. The interest rate is expressed as a percentage of the total or outstanding loan amount, by the lender to the borrower. This amount is known as the principal amount.  

Interest rates apply for various reasons and here are just three of the reasons. 

1. They are a form of profit 

To banks and that is why banks charge borrowers a little higher interest rate than they pay depositors so they can profit. 

2. Interest rates encourage saving 

Banks pay their customers an interest rate on deposits because banks are borrowing that money from their customers. Usually banks use the deposits from savings or checking accounts to fund loans. And the paying of interest rates by banks to their customers encourages people to make deposits.  

3. Interest rates drive economic growth 

Low interest rates bring about low mortgage rates and this has the same effect as lower housing prices, stimulating demand for real estate. Savings rates also fall. When savers find they get less interest on their deposits, they might decide to spend more. They might also put their money into slightly riskier, but more profitable, investments. That then drives up stock prices. Low interest rates make business loans more affordable. This in turn encourages business expansion and new jobs.