What are the Meanings of Interest?

Interest is the remuneration that someone pays for the temporary provision of capital or money. Most of the time there is talk of interest in connection with financial transactions. For example, customers receive interest from banks for their money. Interest must also be paid to the bank on a loan. The amount of the interest is basically contractually agreed. Depending on the market situation, the interest rate can be higher or lower.

  • Current interest rates on specific projects, you can compare with the following computers: overnight interest rates, fixed deposit rates , lending rates , interest on building loans .
  • Further information and charts on current developments can be found in the Interest Rate Development and Interest Forecast Guide .

Interest on investments

Most often, consumers need to calculate interest when looking for investment opportunities or loans. For example, customers are looking for banks that offer the highest possible interest rate for overnight or fixed-term deposit accounts . Call money accounts are accounts that offer higher interest rates than checking accounts. Just like checking accounts, however, they have the advantage that you can have your money at your disposal at any time. A fixed deposit account, on the other hand, is suitable for investors who want to invest a certain amount for a fixed period of time, for example three, six or twelve months. Before the deadline has expired, the customer cannot get his money. In return, the bank guarantees a fixed interest rate for the entire term, which is usually higher than with overnight money accounts.

Calculation example

For example, if a bank offers an interest rate of 2 percent pa (“per annum” – “per year”) for a term of two years for a fixed-term deposit account, the interest for a deposit of 1,000 euros is calculated as follows:

Interest = 1,000 euros * 0.02 * 2 = 40 euros

Taxes and inflation reduce the interest income

The saver lump sum allows German consumers tax-free interest income of up to 801 euros per year. If the interest income is above this amount, it must be taxed. In addition, inflation must be taken into account. The inflation rate is often just offset by today’s very low interest rates – in 2017 the inflation rate in Germany was 1.8 percent.

Interest on Loans

Historically, the debit interest on loans has usually always been higher than the interest on savings deposits. Because with overnight money, fixed-term deposits and savings plans, banks actually borrow money from consumers and pay them credit interest for it. They then lend this borrowed money to other consumers as an installment loan or mortgage loan. Banks make profits from the difference in interest rates between investments and loans.

Return on interest: the compound interest effect

Investors can again receive interest on the interest income from savings – this is known as compound interest. While with some banking products the interest is paid annually to the saver, with other products that use the compound interest effect, the interest is invested. As a result, the interest income is even higher a year later than the year before. The disadvantage: when it comes to a fixed-term deposit account, the saver cannot access the interest income.

Calculation example

The investor invests EUR 10,000 in the 1st year and receives an assumed 5% interest. At the beginning of the second year he has 10,500 euros and also receives 25 euros in interest for the interest income (500 euros), so that at the end of the second year he already has 11,025 euros. Viewed over many years, this compound interest effect leads to enormous assets that are only owed to the time factor.

Compound interest effect on debt

If you get into debt and can no longer repay your installments, your mountain of debt only grows due to the compound interest effect . Therefore, it should become the top rule to only borrow money, and over the shortest possible period of time, if you are able to comfortably repay the installments with your income.

ECB key interest rate at historic low

In the fight against the financial and debt crisis, the European Central Bank (ECB) lowered its key interest rate from 1.0 to 0.75 percent in July 2012. This means that the key interest rate for banks was below one percent for the first time in the history of the ECB. The ECB wanted to stimulate lending in the euro zone with low interest rates and thus stimulate the weak economy in a number of member countries. Since then, it has continued to decline until it reached 0 percent in 2016. The key ECB interest rate determines the conditions at which banks and savings banks can obtain money from the central bank. However, the lower the key interest rate, the greater the risk of inflation.

Meaning in history

According to digopaul, the history of interest began before that of money. Before the creation of metal money, for example, farmers demanded interest in kind for lending grain. After the harvest, the debtors had to return the loaned amount of grain with a surcharge of up to 50 percent. The surcharge was intended to compensate the farmer for the loss of income, as he could not grow the seed loaned himself. Today’s monetary interest also follows this principle.

There are several theories about the purpose of interest. The Austrian economist Eugen von Böhm-Bawerk came to the conclusion that interest rates are related to increasing income. In the future, a person would expect more in return for the money he lent, since income and living standards also rise. Without interest, nobody would be willing to live more frugally by lending money themselves. According to Böhm-Bawerk, interest is, in short, the price for the time and reward for the lender, as he cannot spend the money himself during this time.