1 min read
An interest rate represents the amount a lender charges a borrower as compensation for making a loan. The interest rate will be defined as a percentage of the loan over an amount of time. For example, a borrower may need to pay the lender 10% of the loan per year.
If the accrued interest is not paid when it is accumulated, then this amount will be added to the outstanding balance of the loan. The next interest payment calculation will include the accrued interest. Paying interest on the accrued interest of a loan is known as compound interest.
The interest rate depends on many factors. Rates will depend on the asset being lent. An asset will have a higher interest rate if the demand for that asset is high or if the supply of it is low. The risk of the borrower defaulting on the loan also affects the interest rate.
A borrower that is considered risky will be charged a higher interest rate. A borrower may provide collateral to make the loan less risky. Collateral can be seized by the lender to mitigate losses if the borrower defaults on the loan.