Loans Interests and Investments | Introduction to Interest | Why we Need an Understanding of Interest on Loans? | Interests on Personal Loan in United States | Interests on Personal Loan in India |

Introduction to Interest

When we talk about interest in financial context, it is the cost of borrowing money from someone like an individual or a bank. At the same time, it is the return on the money that you invest.

Interest is paid as a compensation by a borrower (who takes the money) to a lender (who gives the money) for the use of funds over a specific time period. On the other side, if someone invests the money, interest is the earning gained on the investment that he made for a particular time period.

Interest plays an important role in the financial world. It influences various aspects of both personal and business finances.

Let us take an example:

I need to buy a house and I do not have the amount required with me. I approach a bank and ask them for a Housing Loan. The bank after verification sanctions me the loan, however, for the time the bank is lending me the money, it has fixed an interest rate.

If bank provided me a sum of Rs. 1000000 and the interest rate is 12%. So, I will have to pay back the principal amount i.e. Rs. 1000000 and additional (12% of Rs. 1000000). The additional that I paid is the amount that banks earn as interest.

Interest plays a pivotal role in the financial landscape, influencing various aspects of both personal and business finances. Many businesses take loan to establish and operate their companies. Individuals take loans like, personal loan, car loan, housing loan etc.

We will discuss it in detail all these types of loans and what are the differences.

Why we Need an Understanding of Interest on Loans?

Let us see some points as how the understanding of Loans and Interest is important. Why we Need an Understanding of Interest on Loans?

1. Time Value of Money

If you remember the times earlier, things were a bit or a lot cheaper than what they are today. So, the purchasing power of the money depreciates with time. The value of money decreases with time.

Suppose you gave someone a sum of 1000 for 2 years and after 2 years, he returns only the principal of 1000. However, in these 2 years the value of money has decreased with time. Things that you could have purchased with 1000 are costlier. How, that time value of money can be compensated? To do this, you could set the interest on the amount that you lent to overcome the loss in the value of money with time.

So, the interest at some point is linked to the concept of the time value of money. The amount of money today is considered to have more value than the amount of money in the future. The interest is the mechanism that helps quantify and compensate for this difference.

2. Financial Planning

Understanding of loans and interests and how they work, is important for financial planning. If you are saving for a financial goal, if someone is planning for retirement, or managing debt, you must be aware of the Interests over the money you borrow as loan.

The interest well understood and options using which you can pay off the loans are important. There are different types of savings plans that offer you an interest on the money that you save. Chosen wisely can help you in getting a good return of the money that you invest. That may help in reaching the financial goal that you have made.

Plans like, Simple Saving Account, Fixed Deposits, Recurring Deposits, Term Plans have different interest rates and time periods. If you learn the interest earned well on these with time, it will help you in financial planning.

3. Investment Decisions

As stated earlier, investors evaluate the potential on investments they make. Interest and interest rates play an important role in taking investment decisions. If you well understand the calculation of interest, based on, interest rates and time, you will be able to take a wise investment decision.

While comparing through different investment options, the interests that is earned plays a crucial role. Think once, if the same sum of money gives you a higher return, you will definitely go for it. However, with high returns there are risks involved too. We will discuss these risks in coming posts.

Now that we know the definition, usage, and importance of Interest, let us see some real-life examples to bring these concepts closer to understanding.

Real-life Examples of Loans and Investments

Now that we know the definition, usage, and importance of Interest, let us see some real-life examples to bring these concepts closer to understanding.

1. Savings Account

Saving accounts are simply where you deposit money and can use as per daily needs. If you receive money in cash, you can deposit it to the Savings account or generally salaries are credited to savings account. You can withdraw money as per the need. Generally using the debit card, cheques.

If you deposit the money to savings account and there is a balance maintained over time, the bank pays interest on the amount. This amount is paid with a compound interest and contributes to the growth of money. However, the rate paid is considerably less and depends on the amount deposited.

For example, see below the list of Indian banks and their interest rates on savings accounts. updated October 2023.

Below is the list of annual percentage yield (APY) for U.S. Bank Savings Account | Interest Rates January 2024

The formula in general that describes the calculation of the monthly interest for a general savings account is given below.

Monthly Interest = Daily Balance * (Number of days) * Interest / (Days in the year)

Assuming the daily balance is Rs. 10000 and the interest on savings account is 3% p.a. the calculation will work out as follows.

Monthly Interest = 10000 * 30 * (0.03)/365 = Rs. 24.65

2. Loans and Mortgages

In many scenarios, we take loans. Generally, we pay the principal amount added with the interest to the lender. As discussed earlier, the time value of money is responsible and a factor that sets the interest rate. Moreover, there is a credibility and risk factor with the bank that decides the interest rates.

Interests on Personal Loan in India

Interests on Personal Loan in United States

Average personal loan rates by online lender

Average personal loan rates by banks

Average personal loan rates by credit union

There are other factors that decide the interest rate on personal loans.

• Your income is an important factor that determines the amount you can borrow.
• Your debt-to-income ratio is an important factor. This means how much debt you already have compared to your income. This helps lenders determine the amount of loan that can be offered.
• Your employment status is a factor by which the lenders believe and determine if you can repay your loan.
• Your loan term can impact your interest rate: short-term personal loans have higher interest rates than long-term personal loans.

3. Investments

Investments in different fields like bonds, mutual funds, recurring deposits, term deposits etc. They can become a significant source of income. However, as discussed earlier, with higher interest that can be earned, comes higher risks. We will discuss these risks in detail in more posts.

Understanding these different types of investments, interest rates, and risk associated with each of these investments is necessary for making an investment decision.

Different from Savings account these investments come with a lock in period or minimum commitment timeline. This means that there is a minimum time set for these investments to be held before they can yield the return.

Conclusion – Loans Interests and Investments

Understanding Loans and Interests is a crucial and important part of financial literacy and planning. That helps you decide the bank, financial institutions from where the loan can be taken. The kind of investments that you can make to earn more interest on the amount of money invested. It also helps in deciding the risk factors and consequences of your investments.

I hope you liked this post. Keep Reading. (https://education.thepoemstory.com)