Interest
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Banking basics
A recap of a few things you’d think financial professionals ought to know
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Interest
/ˈɪntrɛst/ (n.)
The return a fellow pays another from whom she has borrowed money for a fixed term. Usually articulated as a percentage rate for the length of the commitment and calculated on the amount borrowed.
In common parlance interest can be fixed, floating, or variable — limited really only by the imagination of the borrower and lender. But as we will see, whether the formula for its calculation over a longer term is static, floating or variable, over the minimum commitment period, all interest is fixed.
Terms
All lending is for a minimum “term” — being a minimum period to which a lender commits to not being able to withdraw her money. The interest rate payable for that minimum term is fixed at the outset. Some terms are finite: at their end, the money becomes due for repayment automatically. Others are “rolling”: unless the borrower asks for its money back at the end of the term, the term renews at an adjusted interest rate to reflect changes in the interest rate market over that period. A third type is a combination of rolling and term, where the term will roll for a defined number of periods before becoming automatically repayable.
The shorter the term, the more likely the arrangement is to be rolling.
A single loan that is made up of a series of rolling fixed terms we call a floating rate loan.
Deposits, for example, are rolling fixed-term loans with an overnight term. You can have your money back with accrued interest and no breakage costs daily.
A floating rate term loan that resets each month is, in essence, a seris of month-long fixed term loans. You can have your money back with accrued interest and no breakage costs monthly. If you want your money back intra-month there will be a breakage cost, but only for the unexpired portion of the loan.
So, in a sense, all interest is fixed interest.