interest rate

1. The percentage of a sum of money charged for its use.

2. The Rate of Return on an investment.
Example: A $50,000 mortgage loan is made at 8% interest and 4 Discount Points. The contract interest rate is 8% and determines the monthly payment amount. The Effective Rate of interest, which incorporates the effects of the discount points, is 8.44% and is the rate of return to the lender if the loan runs to maturity.

Rate, usually expressed as a percentage per annum charged on money borrowed or lent. The interest rate may be variable or fixed. See also Variable Rate Loan.

The various types of interest rates are:

(1) prime (interest) rate: rate charged on business loans to the most credit-worthy customers by the nation's leading banks. The prime rate fluctuates with changing supply and demand relationships for short-term funds.

(2) nominal or stated interest rate: predetermined loan rate. The stated interest rate often differs from the effective interest rate. If the interest is paid when a loan matures, the actual rate of interest paid is equal to the stated interest rate. However, if the interest is paid in advance, it is deducted from the loan, so that the borrower actually receives less money than requested, which will raise the interest rate above the stated rate. The actual rate thus paid is called the Effective Interest Rate, or Yield. It is computed by dividing the dollar interest paid by the amount of loan proceeds available to the borrower. For example, for a $1000 loan with an annual interest of 10% with a provision of interest paid in advance, the effective rate is 11.11% [$100/($1000 minus $100) = $100/$900]. In bonds the Bond Yield usually differs from the nominal (coupon) interest rate.

(3) discount rate: rate the Federal Reserve charges member banks for loans. It is also the interest rate used in determining the present value of future cash flows. See also Discount Rate.

The usual way of calculating interest — as a percentage of the sum borrowed.