4/23/2017

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Interest Rates

Interest is the payment incurred for the use of money or credit. In economic terms, interest is a payment made for the use of capital and it is also made as a payment that is offered to people as an encouragement to save.

An interest rate is expressed as a percentage of the amount of money that is paid for it's use over a specified period of time, usually calculated as an annual percentage for the duration of the debt.

Interest is paid on loans, mortgages, bonds, and savings accounts from banks, savings and loans, credit unions, or other lending institutions. Interest is paid when a person buys a home under a mortgage or other financing plan, or makes a purchase under an installment agreement or other extended credit arrangement, such as car notes, credit cards, and payday loans.

Interest is paid to depositors when they open savings accounts at a bank or other institution. This money is considered a loan to the bank, which then loans the money to others at an interest rate, thereby entitling the depositor's a return of interest on their money. The interest rates paid on a savings account is usually lower than the interest rates a bank charges when making loans.

  • Simple interest is usually paid only on the sum of the money that is owed, called the principal.
  • Compound interest is paid on the sum of the principal, but also on the cumulative total of past interest payments, called compounding the interest, thus the amount paid is called compound interest.

The market rate of interest is determined by the supply of money and the demands for money by borrowers. When the supply of available money for investment purposes increase faster than the needs of the borrowers, the interest rates tend to fall, and, just the opposite when the supply of money decreases and the needs of borrowers increase, the interest rates tend to rise.

Interest rates are also determined by the risk to the creditor, meaning whether or not the debtor will default on the loan. The creditor makes this decision based on the debtors income and credit history. If the debtor's income is sufficient and the credit score is high, the better chance of getting a lower interest rate on the loan, but on the other hand, if the income is marginal and the credit score is low, the likelihood of getting a higher interest rate is greater.

In the housing market, real estate prices and the ability of individuals to purchase property, has a direct relationship with whether interest rates are high or low. If interest rates are low, homes usually sell at a brisk pace and values increase accordingly. But if interest rates are high, it makes it more difficult for buyers to qualify for loans, thereby cooling the housing market.

The Federal Home Loan Bank Board, administered by three members who are appointed to 4-year terms by the president and confirmed by the Senate, is an independent agency within the United States government that sets monetary policies, regulates and controls the supply and flow of money, and supervises the operations of other federal units under it's authority.

In essence, the Federal Home Loan Bank Board was set in place to control the supply of money that enters into the private sector. One of it's functions is to either raise or lower interest rates to maintain a balance between inflation and recession.

In addition, each state has a legal rate of interest. This is implied if the rate of interest is not specified within the loan contract. If the interest rate is in excess of the legal rate, it is called usury, which is illegal under most federal and state laws.

Under the Consumer Credit Protection, or the Truth In Lending Act, loan contracts and credit agreements must disclose the interest rates charged on an explicit and standardized form.

 

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