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
I’m interested in money because I can exchange it for things I want, like food, a house, a big screen TV or a fast car.
I have some money. I like having that money. You don’t have money. I can lend you some money, but then I wouldn’t have my money anymore. You would have it (until you paid me back). Also, there’s a chance that you might not pay me back.
In order to persuade me to lend you the money, you promise to pay me back more than you borrowed. That’s interest. If you seem very likely to pay the money back, then you’re going to have to pay a little extra money back. If you seen less likely to pay the money back, the. You’re going to have to pay more extra money to convince me to lend it to you.
(Time value of money and inflation and opportunity costs are also factors that influence the interest rate that a borrower will pay, but those would be eli12 at least)
Interest is the fee for using somebody else’s money. You want to buy a house or car and don’t have all the money to pay the entire amount, a bank will lend you the money but charges interest in return for borrowing their money. Same when a business or government entity issues bonds… the investor gives their money to be used today, collects interest paying for duration of bond, and then gets their money back in the end. Of if you have a savings account, you get paid interest for letting bank hold your money (they then lend it to other customers and charge them a higher interest rate than they pay you, with that spread in rates their revenue).
Why would I lend you money? If you just promise to pay me back then I’ll be missing out on money now only to end up in the situation I was already in before I gave it to you. (Actually worse if you take inflation into account). And actually you might not even pay me back at all, what if you die? What if you can’t pay it back?
Now if you said you’d pay me back + extra now I actually have an **interest** in giving it to you.
It is the cost of borrowing money. There has to be an incentive for someone to lend money and that incentive is more money.
Interest is the name for the money you pay someone to borrow money from them.
If you borrow money to buy a car, you’re going to pay the lender some extra for loaning you the money.
If you buy a government bond, you’re loaning the government money and they promise to pay you back, plus a little extra.
If you have money in the bank, and they pay you interest it’s because they can use that money to loan out to other people. The bank will give you back your money whenever you ask, but in the meantime they’re using your money and giving you a small cut of the profits.
If you owe the IRS money and don’t pay it, they’ll charge you interest. The money you owe but haven’t paid is like you borrowing money from them; they’re charging you a fee for that money you’ve “borrowed”.
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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