Interest is the premium on a loan, that is added to the principal (amount loaned) when the loan is due. Like rent is the price of using someone’s building or land, interest is the price of using someone else’s money.

Interest generally consists of two components a rent (time) component and a risk component.

  • The rent component is the price of someone forgoing the use of their money in the present. The longer the time they forgo the use of their money (the longer the money is tied up as a loan) the greater the interest rate.
  • The risk component is the price to paid to cover the risk that the loan may not be repaid.