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Unformatted text preview: Why do people pay interest? Lenders demand that borrowers pay interest for several important reasons. First, when people lend money, they can no longer use this money to fund their own purchases. The payment of interest makes up for this inconvenience. Second, a borrower may default on the loan. In this case, the borrower fails to pay back the loan and the lender loses the money, less whatever can be recovered from the borrower. Interest helps to make the risk of default worth taking. In general, the more risk there is of default on the loan, the higher the interest rate demanded by the lender. Finally, and most importantly, lenders demand interest since while the borrower has the money, inflation tends to reduce the real value, or purchasing power, of the loan. In this case, interest allows the balance due to grow as inflation erodes the real value of the...
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- Fall '10