Interest is the price paid to lenders for the use of their money. Interest is figured as a percentage of the amount of money borrowed. For example, a borrower who is charged 12 percent interest would pay $12 a year in interest for every $100 of the loan. Interest is based on the idea that lenders are entitled to a return on their investment. This pays them for giving up their right to use the money for a period of time or to make a profit in other ways.
Interest plays an essential part in commerce. Businesses, governments, and consumers borrow and lend money, and thus they pay and receive interest. Businesses borrow money to buy new machinery or to build new factories. They also raise money by selling bonds to the public. Investors who purchase the bonds are paid interest by the businesses that sold them. Businesses pay interest with higher earnings made possible by the borrowed money. At times, one business invests in another and receives interest on its loan. Governments borrow to make up the difference between the money they spend and the funds they collect in taxes. A government receives interest on money it lends, such as on loans to people who want to establish a business. Consumers pay interest if they borrow to buy a home or an automobile. When people deposit money in a savings account, they are lending funds to a bank or a savings and loan association. Therefore, they receive interest.
People or businesses who lend money have incomes greater than their expenditures, so they let others use their money. Instead of hoarding their surplus funds, lenders use it to earn more money through interest.
Borrowers pay interest so they can make purchases that they could not afford if they had to pay immediately. Suppose that a family wishes to buy a house but has not saved enough to pay the entire cost at once. Instead of waiting until the total amount has been saved, the family can take out a mortgage from a bank or another lending institution. The family can then live in the house while repaying the loan in monthly installments. When consumers buy goods or services on credit, they actually are borrowing money by promising to pay by a future date. If the purchase is made on a revolving charge account, the consumer pays in monthly installments and is charged interest on the unpaid balance on the account.
Wise consumers learn about the interest rates they agree to pay. A few merchants may try to make a profit by selling items at low prices but charging a high rate of interest on credit payments. In some cases, consumers pay a higher interest rate for credit from a store than they would for a loan from a bank.