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What Is The Definition of Interest Rate?

Aug 17, 2007
An Interest Rate is very well described as the price a borrower pays for the use of money he does not own, and has to return to the lender who receives for deferring his consumption, by lending to the borrower. Interest can also be expressed as a percentage of money taken over the period of one year.

An Interest Rate is very well stated as the rate of increase over time of a bank deposit. Rates discussed in the popular press are often actually bond yields. Thus, it will not be wrong to say that the yield on a bond is the interest rate that would make the present value of the bond payment stream equal to the current bond price.

An Interest, which is charged or paid for the use of money, is often expressed as an annual percentage of the principal. It is calculated by dividing the amount of interest by the amount of principal. Interest rates often change as a result of the inflation and Federal Reserve policies.

Lets take an example to understand this well. If a lender such as a bank charges a customer $90 in a year on a loan of $1000, then the interest would be 90/1000 *100% = 9%. Thus the Interest Rate has been calculated here.

There is no easy answer to explain what causes the Interest rates to change, but generally speaking, it is only the inflation that will make interest rates rise.

The rate does fluctuate up and down, every day, hour by hour. Money is a worldwide commodity, and any significant event around the world that looks like it may even remotely affect the economy is the utmost reason for Interest Rate to move up or down.

Here the best examples are politics, wars, economic indicators also known as the employment data, new home sales, car/truck sales, factory orders, etc., governments, natural disasters mentioning the floods, earthquakes, famines, etc. All it takes is a publicly voiced theory or assumption from an influential person (i.e. Federal Reserve Chairman, President of U.S., etc.) and the rates can make very drastic moves.

Types of Interest Rate

Interest Rate can be majorly differentiated into 5 types:

The first and the foremost rate is the Variable Rate. This is the very basic standard interest of the lender. This rate will change whenever the lender alters its lending rate, going either up or down depending upon the rate of the Bank. There can be quite a difference between the variable rates of the various lenders and it is worthwhile shopping.

The second type of Interest Rate is the Discounted Rate. This is where the lender specifies a discount off the variable rate for a given period of time. During this period the Interest payable will vary whenever the lender changes its variable rate and the discount will be taken off the used rate.

When the discount period ends the rate payable usually reverts to the lenders variable rate. The borrower then typically has to agree to stay with the lender for a set period of time or face a withdrawal penalty or early redemption charge.

The third type of Interest Rate is the Fixed Rate. This type of Interest mortgages have the Interest Rate on the excellent loan fixed for a period of time. They thus guarantee borrowers that their mortgage payments will be for a set interval of time.

The borrower is protected from any upward swing in mortgage rates, but also does not benefit from any downward movement. Fixed rate deals many times involve the borrower to agree to a withdrawal penalty or early redemption charge if they decide to pay back the mortgage before the agreed period that the rate is fixed for.

The fourth type of Interest is the Capped Rate. Here is a mortgage where an Interest Rate is charged in line with current prevailing rates, but the borrower is given a guarantee that the rate will not go beyond a sure amount. These types of offers are known basically as limited for a period, two or three years.

The advantage to the borrower is that their mortgage rate can fall but there is a limit as to how high it can rise. At the end of this period the interest will revert to the lender's variable rate.

The last and the fifth type of Interest Rate are known as the Capped & Collared Rate. This is where the interest will not beat a maximum rate cap or fall below a minimum rate collar for a fixed period. At the end of the period the rate reverts to the lender's variable rate.

Finally the concept of Interest Rate has to be taken after a serious decision-making. This proves that it is not at all a very easy task.
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William Smith the author provides much more financial information on many subjects as well as the secret to his success in the market along with 5 Free power stock picks emailed daily so grab your Free subscription on his website at Interest Rate (All is Free)
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