Concept of Interest

Interest

Interest is the price paid for the use of loanable funds (capital) used in the production process.

Pure Interest and Gross interest:

Pure interest or net interest is the payment made only for the services of capital or for the services of money borrowed. Gross interest includes the following items besides pure interest.

a) Payment for risk: The lender has to face the risk of loss of capital due to trade risk and personal risk. Trade risk faced by the borrower arises from the uncertainty of profit in the business and therefore, he may not be able to repay the loan amount in time. Personal risk is due to dishonesty of the borrower.

b) Payment for inconvenience: After lending the money, the lender may urgently need the money for some other purpose. Sometimes, the borrower may return the money at the time when the lender may not be able to reinvest it in any other purpose. These are some of the inconveniences faced by the lender.

c) Payment for work and worry: The lender has to maintain proper accounts. He has to keep the securities (documents, jewels, etc.) safely. Some times, the lender sets legal proceedings against defaulters. All these cause worries to the lenders. By way of compensating all these, the lender charges some thing over and above the pure interest and it is called gross interest.