Definition
Interest is the cost of borrowing on credit.
Analysis
Interest is what it costs to use credit to purchase items or to receive a cash loan. Lenders expect to earn interest on credit accounts for profit.
Interest rates fluctuate based on market conditions. Higher federal funds rates to banks can translate into higher borrowing costs for consumers. Additionally, increased competition from lenders can reduce interest rates.
Risk-based pricing is what allows lenders to charge higher rates of interest to borrowers with lower credit scores. They must charge more interest in order to offset the higher risks of borrowers defaulting on the debt. This is in addition to interest charged that contributes to the lender’s profits.
Interest can be expressed in a number of ways, such as monthly percentage rates or even daily percentage rates. As a result of the Truth in Lending Act, lenders are required to disclose the interest rate as an annual percentage rate. The purpose is to allow borrowers to compare rates and to mandate common disclosure standards.
Interest rates are subject to federal and state usury laws, which limit the amount of interest that can be charged. Interest rates are usually capped at 36% APR, although some loopholes allow for fringe banking outlets to charge substantially more.
