What does an interest rate represent?

An interest rate represents the percentage charged for borrowing money, serving as a key indicator of the cost of debt. When individuals or businesses borrow funds, the lender assesses the risk associated with lending money and establishes an interest rate accordingly. This rate is expressed as a percentage of the total amount borrowed and determines the additional amount borrowers will pay back over the principal loan amount.

For example, if you borrow $1,000 with an interest rate of 5%, you would pay $50 in interest over the course of a year, assuming simple interest. This concept is fundamental in finance since it directly impacts both borrowing and lending activities. Understanding interest rates is crucial for making informed financial decisions, whether taking out a loan or saving money.