In finance, interest has three general definitions.
- Interest is a surcharge on the repayment of debt (borrowed money).
- Interest is the return derived from an investment.
- Interest is the right to one's claim in a corporation, such as that of an owner or creditor.
In economics, interest is the return to capital achieved over time or as the result of an event.
In population dynamics the rate of population growth (the interest rate) is sometimes referred to as the Malthusian parameter.
This article covers the "financial" use of the term.
In common use the term "interest" is seen as rent paid for the use of money. As with any rental, the market price (or rate) is subject to change to reflect market conditions. The fraction by which the balances grow is called the interest rate. The original balance is called the principal. Interest rates are very closely watched indicators of a financial market, and have a dramatic effect on finance and economics.
The fact that lenders demand interest for loans can be attributed to the following reasons:
- Time value of money or time preference
- (TVM: Having money now is more valuable than having it at some future time because interest is earnt)
- (TP: Interest is the value borrowers place on having money now)
- Opportunity cost
- (OC: The cost in terms of options no longer available once one particular option is chosen)