Glossary Terms

Interest Rate

The percentage of a loan amount that it costs to borrow money.

The interest rate is the percentage of a loan amount that it costs to borrow money.

Interest rates are expressed as percentages. If, for example, a lender wishes to earn $50 for lending someone $1,000 for a year, the interest rate is this:

$50 income / $1,000 borrowed = .05

That .05 is another way of writing 5%. By multiplying the result of the interest rate calculation by 100, the number can be expressed as an interest rate. So .05 * 100 = 5 percent.

The interest rate is used to calculate a loan payment. If a bank customer wishes to borrow $1,000 and repay it in a year, and the lender charges a 5 percent interest rate, the borrower multiplies the $1,000 by 5 percent, or .05, and gets $50, So she knows that in a year she needs to bring the lender $1,050 to repay the loan.

However, most borrowers don’t pay loans off all at once. And most lenders don’t calculate interest once a year. Mortgages and other loans are usually repaid in monthly installments, and interest is usually compounded monthly as well.

If the borrower repaid that $1,000 in 12 monthly installments, she would pay $85.61 per month. In 12 months, she will have repaid the $1,000 and paid an additional $27.29 in interest at a 5.0 percent interest rate.

Chart showing interest rate and affect on interest paid on a loan