Interest Rates

The price or amount that someone pays for the transitory use of someone else's funds is called interest. Interest could also mean the payment that someone receives for giving up the ability to spend money temporarily for the purpose of lending the money to someone else.


The definitions clearly describe the relationship between a lender and a borrower. Lenders would not willingly allow anyone to borrow or allow him or herself the sacrifice of not spending money if there is no interest. On the other hand, borrowers would be only too happy to spend if they do not have to worry about interest rates.

If, for example, you intend to borrow $100 per year, the interest rate would be 10 percent per year. This is due to the fact that interest rates are expressed as percents per year. In the end, you would have to pay the $100 you owe and an additional $10 in interest.

There are reasons why interest rates exist, but they are different from the perspectives of a lender and a borrower. From a lender's point of view, an interest rate makes up for increasing prices of goods. This is a means to compensate him for giving up his power to purchase by lending his money to others. An interest rate also makes up for the risk that a lender makes in having his money borrowed. For bank lenders, an interest rate allows them to stay in business. The profit from interest rates allows banks to continue running.

From a borrower's point of view, an interest rate allows him to spend now, rather than later on items. Interest rates also allow a borrower to make a larger or a more expensive purchase such as a house or a car. By availing of interest rates, education becomes affordable to some borrowers. Willingness to pay interest allows business borrowers to purchase equipment, buildings and inventories to make investments and increase their profits. Some borrowers are willing to pay interest rates because they are after associated tax advantages.

An example of this is the mortgage interest, which is tax deductible in the United States. During the calculation of the income tax, the mortgage interest is subtracted. Banks, on the other hand, are willing to pay interest rates to their depositors. This is because the deposits allow them to lend money at higher interest rates and get bigger profits in return. Also, it is a known fact that banks tend to charge higher interest rates on loans than on deposits.

Moreover, interest rates are income to people who are willing to forego the use of their money. As mentioned earlier, banks give interest rates to their depositors. Similarly, you will gain interest income if you purchase a Savings Bond. On the other hand, if you think about it, an interest rate is a cost to borrowers. If the money loaned is not fully paid, interest rates have to be paid. Lastly, an interest rate is a means to move funds to where they could earn the highest rates.

Canada Mortgage meltdown?

Merrill Lynch is warning that Canada could be headed for a housing and mortgage meltdown similar to the one that has devasted the United States economy.

A report issued Wednesday by Merrill Lynch Canada economists says many Canadian households are more financially overextended than their counterparts in the United States or Britain.

They say it’s only a matter of time before the “tipping point” is reached and the housing and credit markets crack in Canada.

The Merrill Lynch Canada report by economists David Wolf and Carolyn Kwan acknowledges that the analysis is more pessimistic than the prevailing view.

Many economists have been saying that Canada’s housing and banking sectors are much more stable than their American counterparts and will likely slow down but not crash.

But Merrill Lynch — whose U.S. parent is one of the biggest victims of a crisis in financial markets that is rooted in the American housing and mortgage meltdown — says Canadians should be wary.

Household net borrowing in Canada amounted to 6.3 per cent of disposable income in 2007 — meaning they’re carrying more debt than households in the United Kingdom and not far off the peak U.S. shortfall in 2005 — just before the subprime mortgage crisis erupted.

“These data imply that the Canadian household sector is now overextending itself as much as the U.S. or U.K. ever did, challenging the consensus view that Canadian lenders and borrowers have been far more conservative through the cycle,” the Merrill report says.

It also says housing prices are now falling and inventories of unsold homes are rising sharply in Canada suggesting that this market turnaround will not be a transitory phenomenon.

However, the prevailing view is that Canada’s lenders have issued few of the type of subprime mortgages that sparked the U.S. crisis, which is continuing to ripple through the financial system.

In addition, many observers argue that Canadian residential properties are, by and large, not overvalued — considering the strength of regional economies in resource-rich provinces.