Interest

By:

James Knight

James is a lead editor for Invezz, where he covers topics from across the financial world, from the stock… read more.

Updated: Aug 20, 2021

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The amount paid by a borrower to a lender in payment for a loan. Interest may be simple or compound. Simple interest is a fixed rate on a stated sum. The same amount is paid or accumulated each year irrespective of the amount borrowed, for instance £100 lent at 5 per cent simple interest would earn £5 a year. If the interest were not paid when due, it would not itself earn interest. But if a sum is invested at compound interest and the interest is allowed to accumulate, the interest is calculated each year on capital plus interest already accumulated. Interest is normally stated at a fixed rate per cent per annum. If money is borrowed at 5 per cent interest, then the borrower must to the capital sum. This is often stated as £5 per cent. In certain contracts there is an important difference between nominal interest and real interest. This always applies when repayment is to be made in instalments starting within a period of less than one year. Examples are hire purchase contracts and bank personal loans. If £1,000 is borrowed for one year at 10 per cent and the loan is repayable by monthly instalments beginning in one month’s time. then the real interest is considerably more than 10 per cent. Although only £100 interest is to be paid, the average amount outstanding over the period will be not £1,000 but £5(X) and the true rate of interest is 100/500, i.e. 20 per cent.

Reference: The Penguin Business Dictionary, 3rd edt.