Gross Interest and It’s Components

In general terms, interest is the amount paid by the borrower to the lender for using the borrowed funds for a certain period of time.

In economics, interest refers to payment made for availing the services of capital.

Some of the Economists Have Defined Interest As Follows:

According to Eastham, “Interest is the payment for parting with the advantage of liquid control of money balances.”

In the words of Batch, “Interest is the price paid for the use of money or credit.”

As per J. M. Keynes, “Interest is the premium which has to be offered to induce people to hold their wealth in some form other than hoarded money.”

Let us understand the concept of interest with the help of an example. Suppose the rate of interest on home loan is 9%. This implies that the individual who have borrowed the loan needs to pay 9% of the total amount of loan for utilizing the capital. Interest is actually the price for using capital. It is expressed in the form of percentage return on a capital invested.

According to Samuelson, “The market rate of interest is that percentage return per year which has to be paid on any safe loan of money, which has to be yielded by any safe bond or other type of security, and which has to be earned on the value of any capital asset (such as a machine, a hotel building, a patent right) in any competitive market where there are no risks or where all risk factors have already been taken care of by special premium payments to protect against risk.”

Interest can be classified as gross and pure interest. Gross interest refers to the total amount paid by a debtor to the creditor. On the other hand, pure interest refers to the amount paid after deducting the amount for insurance against risks, inconvenience, and other services of the lender. Therefore, pure interest is the payment for loan able funds only.Now, let us discuss the various components of gross interest below.

Components of Gross Interest:

Gross interest refers to the total amount paid by a debtor to the creditor.

The following are the components of gross interest:

i. Pure interest:

Refers to the amount paid by a debtor for availing the services of capital only.

ii. Insurance:

Refers to the amount paid by the debtor for covering the risk associated with the lending of money. The risk can be of two types, personal risks associated with the borrower and trade risks are associated with the changing conditions of a business. Therefore, the debtor has a risk that the borrower may not pay the money back or the money is lost in case of failure of business.

iii. Wages of management:

Implies that a creditor has to maintain the records of transactions related to the payment of loans and receipts of interest. For this purpose, the lender may hire a clerk and needs to pay wages to the clerk. In such a case, there wages are included in gross interest.

iv. Inconvenience return:

Refers to the amount paid by the debtor because of the inconvenience faced by the creditor as the amount of compensation. When the creditor lends the money, his/her control over money is stopped. He/she can lose the various opportunities to invest for the best alternatives. Inconvenience can be of two types.

Firstly, the shortage of money when required by the lender. This results in borrowing money from others on interest.

Secondly, the lender gets money when he/she does not have any better option to invest, which results in the loss of interest. Therefore, the lender expects compensation against such loses.