Interest Rate – The Lifeline Of A Country’s Economy

An interest rate is the price a borrower pays to the lender for using his money for a specific purpose. The rates are usually calculated on a monthly basis. However, they are expressed as percentage rates calculated over the period of one year.

Effects Of A Fluctuating Rate Of Interest On The Economy

Typically, banks and government financial institutions set rates of interest. They vary from country to country, and as such, the rates are guided by the performance of financial sectors and money markets. The inflationary tendencies of a market are one of the principle causes. The risk associated with the lending process is another reason why lending rates fluctuate. There is always an inherent fear that the borrower may go bankrupt, or make deferred payment, which can affect the earning potential of the lender. To cover such occurrences, they may charge higher rates of lending. Thus, interest rate comparison must be done but it is not that easy. It is periodically affected by Constant minor changes, and many other factors.

Additionally, the lender prefers that his resources be available to him immediately when the need arises. Lending blocks the availability of funds for a decided period. The lender may also have to pay taxes for the profits earned from lending business. To compensate the losses due to tax, he may lend money at a higher rate. But it is important for borrowers to go for interest rate comparison.

A bank interest rate is the rate charged by a country’s federal bank on loans and advances to control money supply in the banking sector. This also helps in controlling the economy and stabilizing the country’s exchange rates. Even a slight fluctuation in bank rates impacts every aspect of the country’s economy. For example, the stock markets’ indices can react very sharply, even to small changes in the rate of interest. The changes in rates can also affect the mortgage rate because of the long-term effect that it can have on the sums loaned. Thus, interest rate comparison is a must

Types Of Rate Of Interest

Interest rates are of two types, namely simple and compound. Simple interest is the interest paid on the amount loaned, also known as Principle amount, or on that portion of the amount that remains unpaid. Compound interest is similar, but different in the way the interest amount is calculated. The balance interest amount is added to the money due to be paid. Over a period of time the interest can become larger and beyond manageable proportions, if payments or installments are not paid on time.

In addition to the above, there are fixed and floating rates of interest. Rates that do not change over the term of the loan are called fixed rates. Floating rate is charged when the rates are changeable at any point in time during the loan term. Banks usually charge a combination of two types of loans with the initial periods in the fixed mode, and the subsequent part of the term under the flexible rate system.