rate, usually expressed as a percentage per annum charged on money borrowed or lent. The interest rate may be variable or fixed. See also variable rate loan.
The various types of interest rates are:
- prime (interest) rate:rate charged on business loans to the most credit-worthy customers by the nation's leading banks. The prime rate fluctuates with changing supply and demand relationships for shortterm funds.
- nominal or stated interest rate:predetermined loan rate. The stated interest rate often differs from the effective interest rate. If the interest is paid when a loan matures, the actual rate of interest paid is equal to the stated interest rate. However, if the interest is paid in advance, it is deducted from the loan, so that the borrower actually receives less money than requested, which will raise the interest rate above the stated rate. The actual rate thus paid is called the effective interest rate, or yield. It is computed by dividing the dollar interest paid by the amount of loan proceeds available to the borrower. For example, for a $1000 loan with an annual interest of 10% with a provision of interest paid in advance, the effective rate is 11.11% [$100/($1000 minus $100) = $100/$900]. In bonds the bond usually differs from the nominal (coupon) interest rate.
- discount rate: rate the Federal Reserve charges member banks for loans. It is also the interest rate used in determining the present value of future cash flows. See also discount rate.
cost of credit, expressed as a percentage rate, computed from the ratio of interest to principal. Some interest rates are set by supply and demand in the money market, for example, the rate paid by the U.S. Treasury Department when it auctions Treasury bills. Interest rates on bank loans are administered rates, which means they are determined by the lender. The bank prime rate, for example, is determined independently by each bank, even though many banks follow the actions of money center banks in repricing their prime rate. Variable interest rates, such as the rate charged in an Adjustable Rate Mortgage, are determined from an index rate, or Cost Of Funds Index, that by regulation must be outside the control of the lending institution.
cost of using money, expressed as a rate per period of time, usually one year, in which case it is called annual rate of interest.
rate of interest charged for the use of money, usually expressed at an annual rate. The rate is derived by dividing the amount of interest by the amount of principal borrowed. For example, if a bank charged $10 per year in interest to borrow $100, they would be charging a 10% interest rate. Interest rates are quoted on bills, notes, bonds, credit cards, and many kinds of consumer and business loans.
the percentage of a sum of money charged for its use.
the rate of return on an investment.
Example: A $50,000 mortgage loan is made at 8% interest and 4 discount points. The contract interest rate is 8% and determines the monthly payment amount. The effective rateof interest, which incorporates the effects of the discount points, is 8.44% and is the rate of return to the lender if the loan runs to maturity.
