What is Interest Rate?

What is Interest Rate?

Is Interest Rate Hard to Understand?

Whether you are lending or borrowing, the involved interest rate can take place as added fees when you need to pay back the debt. Interest rates can be viewed as a cost of lending which is calculated by various factors such as the amount lent, duration, and credit of lenders. 



An example of how interest rates are applied is any individual/company (Mr. A) who wants to borrow 10,000 baht with a 5% interest rate, the lender needs to pay the borrower 10,500 baht on the payment’s date. 





Importance of Interest Rate



The existence of interest rates can impact the economy in both good and bad ways. In order to achieve a better level of money circulation in the economy, banks play the middleman role between lenders and borrowers to compensate lenders who make a deposit to banks by charging an interest rate to the borrower and take some as insurance.



The effectiveness of interest rate control yields better results in the economy by lowering interest rates, which can raise the amount of expenses, lending, and investments in the economy as a whole. However, the chance of inflation can be increased due to the difference between money supply and resources. 



On the other hand, high levels of interest rates can result in less spending, lending, and investments as saving and paying the debt is considered a wiser option. This process prevents the chances of inflation from occurring. 



Interest rates are important to the economy in both stimulating or controlling inflation rates to provide equilibrium.





How can interest rates be applied?



As banks act as a loaning service provider, interest rate also acts as means of compensation to lenders who deposit money to banks. Without compensating interest, saving money with banks would be less popular as some may find that there is no need to give their money to others instead of saving it on their own.

 

Borrowing can occur for numerous reasons, such as borrowing to spend for your own needs, paying tuition fees, investing in a business, etc. Debt can be paid in terms of monthly payments, yearly payments, or within the boundaries of a certain agreement between lenders and borrowers. 



Gaining interest rates by providing loans seems to be an alternative method of investment for the lenders. Interest rates can be provided in the forms of Annual Percent Rate (APR) or Annual Percent Yield (APY); which can be methods of making a profit from money as well. 





What is Compound Interest Rate?



Compound Interest rate is an interest rate found in Annual Percent Yield (APY) methods sought after to provide better outcomes. Whether with or without a middleman, the interest rate will be calculated from the amount of deposit plus monthly, quarterly, or yearly earnings. 



The longer it takes, the higher compensation you will earn from the deposit using APY. This is a type of interest rate but differentiated with Annual Percent Rate (APR) which directly provides earning from the amount of deposit.





Negative Interest Rate 



Negative interest rates were first recognized in 2012 in Denmark after a previous stimulation of the economy through lowered interest rates proved ineffective.



To maintain equilibrium central banks can offer negative interest rates, wherein the paid debt is even lower than the funds borrowed. This is performed so that individuals or companies are willing to spend, loan or invest more due to the fewer amount of debt gained by loans from the bank or even loss of the deposited money. 



During an economic downturn, saving seems to be a better option in order to wait for the economy, but without spending, the economy won't be able to recover itself.  A negative interest rate has been used to prevent further loss and indirectly persuade individuals or companies to spend, loan and invest more which is considered a last resort under extraordinary economic situations.





Conclusion



Interest rates appear to be the key in maintaining economies, whether it's lowering or increasing interest rates, which both can benefit economic growth and control inflation rates simultaneously. 



Understanding how interest rates work will undoubtedly help with money and risk management, this information can be used to analyze the economy's overall standpoint to find a proper time of spending or investing.





Reference:



Binance Academy, Investopedia

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