An interest rate is the rate that is charged or paid for the use of money. Interest rates are typically an annual percentage of the principal amount, known as the annual percentage rate, or APR. Lenders use the interest rate as a way to compensate for the loss of the asset's value. For example, the lender could have invested the money that it gave to a borrower instead of lending it. Therefore, the lender uses the interest rate to charge the borrower in an effort to recover some of that potential loss.
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An interest rate is much like a rental charge. The borrower is paying a fee in order to borrow and use the money or asset. When it comes to credit cards and loans, the interest rate affects the cost of borrowing. Each bank sets its own interest rate, but local rates are typically the same across banks. Interest rates tend to rise during times of inflation or when there is a greater demand for credit.
Individuals are offered funds at a certain interest rate that is based on their risk. If the borrower has good credit and is considered low-risk, meaning he or she is likely to make payments on time, then the interest rate will usually be low. However, high-risk borrowers will experience higher interest rates.
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