Sunday, March 26, 2017

Fundera Whiteboard: What is an Interest Rate?

You’re watching TV one day and the newscaster announces “The Federal Reserve has decided to raise the Federal Funds rate .25%.” The next day you get a letter in the mail about a credit card offer with an advertised 0% intro APR. Later that month, you decide to shop for a loan for your small business on

What do these 3 situations have in common?

They all rely on interest rates.

But what is an interest rate, really?

Specifically for small business loans, it’s the percentage charged by a financing company to a borrower for lending a sum of money. An interest rate is quoted as a percentage of the amount of money you borrow. So how do interest rates work? Let’s see it in action!

Let’s say you borrow $10,000. The interest rate is 10%. The term is 2 years—with monthly payments and no other fees.

To get your monthly payment—plug in the interest rate, term of the loan, and principal amount borrowed—into a loan calculator.

Based on that, we’ll see that for this loan your monthly payment will be $461.45. When we multiply this number by 24, we see that we’re paying back $11074.78 to borrow $10000. So we’re paying $1074.78 in interest over the term of the loan.

So in summary: an interest rate is the cost of borrowing money. It’s what you’ll use to calculate the total amount you’ll owe the lender for using their money.

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