What is it for and why? I found a lot of questions on interest rate but not what interest itself is
Thanks in advance 🙂
Edit: Thank you for all the replies i am now a financial god of wisdom, i’m not going to reply to unless something is unclear to me but comments will all be read
In: 9
Imagine you go to the grocery store to buy some eggs. You notice you didn’t bring your wallet, and ask the grocer if you can pay next week. They agree. This sort of “buy now, pay later” dynamic happens all over the place. It makes things easier for everybody as long as you have some level of trust going on.
Now, imagine that instead of eggs, you want to buy money. Buying money and paying right away doesn’t make any sense (unless we’re talking about eg buying dollars with euros), but you want is to buy money today and pay later, same as with the eggs. Why would I sell you the money? Because I want to make money myself, same as I would with my eggs, so I say “you get $100 now and pay me back $110 later”. On your end, why would you be willing to accept that deal? Because of a really important concept in economy: money today is worth more than money tomorrow. Maybe that money means you can buy a cow today and milk it for $120 worth of milk before you have to pay me back. I made $10, you made $10, everybody’s happy.
Interest is those $10 I charged you, which makes it worth my while to let you buy money now to pay me money later. It’s a combination of what I want my profit to be, plus some amount as insurance against the possibility that you might not pay me back.
That last part is important: If I do this 100 times and one person bails out on me, i lose $100. If I charge everybody $111 instead, that extra dollar from 99 people means I only lose $1. This is what credit ratings are for: I’ll charge you more if you have a history of not paying your dues, and will charge less if you have a history of paying people back.
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