What is the interest rate, and how does it work?

Asked 5 years ago

Can anyone give me a simple definition and an example?

Andia Rispah Igobwa

Monday, August 16, 2021

The interest rate is the cost of borrowing money or other financial assets.
An example of interest would be a $20 bill borrowed for one year at an annual percentage rate (APR) of 10%. At this APR, the total interest paid on that $20 over one year is calculated as $2.05.
Therefore, the effective APR for borrowing $20 for one year at 10% is 12%.
A fixed-rate mortgage might have an APR in the range of 3-6%, and a credit card typically carries rates around 20% APR. 
However, when considering only variable-rate loans such as home equity loans (HEL), short-term personal loan apps, or payday lenders, the APRs are often north of 30%. They can even reach over 100% (!). That's why it is important to understand what your APR means before you sign any loan documents for your next big purchase or top-up.