Aninterest rate refers to the amount received as a fraction of aborrowed sum of money. When it comes to borrowing money, one of thegreatest factors that influence the borrower’s decision is theinterest rates at lending facilities. Interest rates affect bothborrowers and savers (Vose, 2008). In the case of borrowers,low-interest rates translate to low interest payments when they startrepaying the borrowed money. In contrast, low interest rates meanlittle interest for saved money, a dreadful scenario for savers.
Whenmaking a major purchase, for instance, a car or a house, many peopleprefer to borrow money from lending institutions. When consideringtheir options, borrowers have to check out the interest rates atdifferent lending facilities. After this stage, they compare whateach institution has to offer and make a decision on which one toborrow from. In making this decision, interest rate plays a key role.For a borrower, the amount of money they will pay on top of theamount they borrowed money is directly determined by the interestrate (Vose, 2008). The higher the interest rate, the more interestthey have to pay for loan or mortgage repayment.
Severalfactors determine interest rates. One of the key factors is risk. Theinterest on any borrowed money represent the returns that the lenderstands to gain once the borrower finishes their repayment. Thisrelationship shows that to the lender, the borrowed money is aninvestment and the higher the interest they charge, the riskier theinvestment is. The risk in this context refers to a scenario wherethe borrower defaults on the loan. As Vose (2008) agrees, is notachievable to precisely establish the possibility that a borrower maydefault on a loan. As a result, historical records are used todetermine which kinds of borrowers are likely to default on a loan,and then adjust their interest rates accordingly to avoid such ascenario. The higher the risk associated with a certain category ofborrowers, the higher their interest rate.
Vose,D. (2008). Riskanalysis: A quantitative guide.Chichester, England: Wiley.