Legal Definitions - interest

Interest refers to the cost associated with borrowing money or the income earned from lending money. When an individual or entity borrows funds, interest is the additional sum paid back to the lender beyond the original amount borrowed (known as the principal). Conversely, when an individual or entity lends money or deposits it into certain financial accounts, interest is the extra money received as a return on those funds.

This additional sum is typically calculated as a percentage of the principal, which is called the interest rate. Interest rates can be fixed, meaning they remain constant throughout the loan or deposit term, or they can be variable, meaning they may change over time based on market conditions.

• Example 1: Home Mortgage

  A couple purchases a new home and takes out a mortgage loan for $400,000. This $400,000 is the principal. Over the 30-year term of their loan, they will not only repay the $400,000 principal but also an additional amount, perhaps $350,000, which is the interest. This interest represents the cost they pay to the bank for the privilege of borrowing the money to buy their home.

• Example 2: Business Loan for Expansion

  A small business owner secures a $100,000 loan from a bank to purchase new equipment and expand operations. The $100,000 is the principal. The loan agreement stipulates a 7% annual interest rate. Each month, the business owner makes payments that cover a portion of the principal plus an additional amount calculated at 7% of the remaining principal. This additional payment is the interest, serving as the bank's compensation for providing the capital.

• Example 3: High-Yield Savings Account

  An individual deposits $25,000 into a high-yield savings account at a bank. The $25,000 is the principal. The bank offers an annual interest rate of 2%. Each month, the bank calculates 2% of the account balance (divided by 12 for the monthly rate) and adds that amount to the individual's savings. This additional money, which grows over time, is the interest earned by the individual for allowing the bank to use their deposited funds.