DEFINITION: The term “interest” signifies a payment by a borrower to a lender (or investor or depositor) that is above the principal amount of the original loan.
From the point of view of the lender, interest is profit earned by providing the borrower with the use of the principal amount of money for a fixed period of time.
ETYMOLOGY: The term “interest” derives, via Middle English, Anglo-French, and Medieval Latin, from the Latin verb intersum, interesse, meaning “to be between,” “to concern,” or “to be important.”
Thus, in modern parlance, the economic/financial use of the word “interest” is borrowed from the everyday sense in which the “interest” that individuals have in a thing is the concern they have for it, or its importance to them.
Here are some examples of the common-language use:
Q: “What are you main interests?” A: “Victorian novels, classical music.”
Q: “Did you go to the demonstration?” A: “No, I felt it was not in my interest to be seen there.”
USAGE: The concept of “interest” is distinct from several superficially similar concepts.
For example, interest must be distinguished from fees, which are payments for services rendered that have nothing to do with borrowing or lending money.
Interest is also distinct from dividends. Like interest, dividends are paid by corporations to their shareholders. However, dividend payments are not made on the basis of a specific rate agreed upon in advance, but rather as a share of a corporation’s profits.
Thus, a corporation’s dividend payments depend upon its economic performance. Namely, dividends are paid when the company’s revenues exceed its total costs.
Interest payments, in contrast, are typically payable independently of a company’s economic performance.
It is worth quickly reviewing the history of interest.
Christianity and Islam, at certain periods of their history, forbade making a profit on moneylending.
That is, while Christians and Muslims could freely lend money, they could not accept in return any monetary payment above the principal amount lent.
It was for this reason that Jews filled the economic void created by these prohibitions against lending money at interest, which is to say, on a commercial basis.
For this same reason, during the late Middle Ages and the Renaissance, Jewish families organized the first modern-style banks in northern Italy, which played an essential role in fueling the growth of capitalism and, eventually, the economic take-off of Western Europe as a whole.
This history highlights the primary economic importance of interest—which is the stimulation of entrepreneurship and the financing of new business ventures.
Interest is considered one of the main factors that influence the economic activity of a society. Thus, it is unsurprising that a great many further distinctions and analytical concepts relating to interest have been made by modern economic science.
Here, we will just mention two: yield and the prime rate.