What is interest?

Interest is best defined as the cost of borrowing money, usually expressed as a percentage of the principal amount. This concept is fundamental to understanding loans and credit. When an individual borrows money, they typically do so with the understanding that they will need to pay back not only the original amount borrowed, known as the principal, but also an additional amount, which is the interest. This interest compensates the lender for the risk and the opportunity cost of lending their money.

The interest rate can vary widely depending on various factors, including the borrower’s credit history and the terms of the loan. It can be expressed in different forms, such as fixed or variable, but always reflects a percentage of the principal amount being borrowed.

Understanding interest is crucial for managing personal finances effectively, as it affects how much one will ultimately pay back on a loan and can significantly influence financial planning and decision-making.