What is interest?

Interest is defined as the cost of borrowing money, and it is typically expressed as a percentage of the principal amount borrowed. When an individual or a business takes out a loan, they agree to pay back the original amount plus an additional percentage that serves as the lender’s compensation for the risk and opportunity cost associated with lending the money. This percentage can also reflect the time value of money, which means that money available now is worth more than the same amount in the future due to its potential earning capacity.

In essence, interest can generate income for lenders or institutions, and it is essential in various financial transactions such as loans, mortgages, and credit cards. Understanding interest is crucial for effective personal finance management because it can affect everything from the cost of borrowing to the growth of savings over time.