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Gross Interest And Pure Interest

 Interest, Gross and Pure Interest

Meaning

            In general, interest is a payment made by a borrower to the lender for the money borrowed and is expressed as a rate percent per year. According to Carver, “Interest is the income which goes to the owner of capital.” Keynes, a well known name of economists, regarded interest as a purely monetary phenomenon, payment for the use of money. It is the reward for parting the liquidity of money.

The neo-classical economists nevertheless define it as the price for the use of loanable funds. But the modern economists in their effort to avoid these divergent and controversial views about the nature of interest, have explained it in terms of productivity, saving, liquidity preference and money. Thus they explain it in terms of the demand and supply of money.

Gross and Pure Interest

            The payment which the borrower makes to the lender excluding the principal is gross interest. It is a composite item which includes the following payments:

  1. Pure or Net interest

    It is the payment for the use of capital or money only. This is interest the pure economic sense. It is normally the sane during a period of time even in different markets.

  1. Reward for Risk Taking

    The lender exposes him to risk when he lends money. Gross interest includes the reward for risk taking. The greater the risk factor, the higher the rate of gross interest. Unsecured loans are more risky than secured ones and they carry a high premium rate.

  1. Reward for Inconvenience

    When a lender loans money, he foregoes its use for the duration of the loan. His money is locked up and cannot be used for more profitable purposes. Or, if he needs this amount for his personal use, he will have to undergo the inconvenience of arranging it from some other source. In fixing interest rates, the lender includes in it the reward for such inconveniences.

  1. Reward for Management

    The lender has to incur outlay in keeping proper accounts of the borrowers. He buys account books and even maintains staff. He has to remind borrowers and sometimes has to file a suit for the recovery of loans. The payment that the lender receives from the borrower also includes the expenses for management.

    Pure or net interest = Net interest + reward for risk taking + reward for inconvenience + reward for management.

    Net interest = Gross interest – (reward for risk taking + reward for inconvenience + reward for management).

Variations in Interest Rates

Interest rates vary from person to person and from place to place. There are many factors which cause variations in interest rates which are discussed as under.

  1. Differences in Gross Interest

    Variations in the rate of interest are due to differences in gross interest such as risk and inconvenience involved, cost of keeping records and collection of loans etc. The greater the risk and inconvenience and the cost of management of loans, the higher will be the rate of interest and vice versa.

  1. Nature of Security

    Interest rate varies with the type of security. Loans against security of gold carry less interest rate than loans against the security of immovable property like land or house. The more liquid are the assets, the lower is the interest rate and vice versa.

  1. Credit Worthiness of the Borrower

    Interest rate also depends on the credit worthiness of the borrower. Persons of known integrity and creditability can get loans on easy terms.

  1. Period of Loan

    Rate of interest also depends upon the period of loan. Long term loan carry higher rate of interest than short term loans. In a long term loan the money gets locked up for a longer duration. Naturally the lender wants to be compensated by a higher rate of interest.

  1. Amount of Loan

    The rate of interest stands in an inverse relation to the amount of loan. The greater the amount of loan, the lower is the rate of interest and vice versa.

  1. Differences due to distance

    Distance between the lender and the borrower also causes differences between interest rates. People are willing to lend at a lower rate of interest nearer home than at a long distance.

  1. Differences in Productivity

    Productivity of capital differs from venture to venture. People are willing to borrow at a higher rate of interest for productive ventures and vice versa.

  1. Market Imperfections

    Differences in interest rates are also due to market imperfections that may be found in a loan market. Money lenders, indigenous banks, mutual funds, commercial banks etc follow different lending policies and charge various interest rates.

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