Loans in the pre-urban societies were made in seed grains, animals and tools to farmers. Since one grain of seed could generate a plant with over 100 new grain seeds, after the harvest farmers could easily repay the grain with “interest” in grain. Also since just so much seed grain could possibly be used, there were natural limits to this lending activity. When animals were loaned interest was paid by sharing in any new animals born. What was loaned had the power of generation, and interest was a sharing of the result. Interest on tool loans would be paid in the product which the tools had helped to create.

In his Ancient Economic History, for instance, Heichelheim, a German-born ancient historian, who specialized in ancient economic history, believed that this kind of lending occurred as early as the neolithic age, with early “food-money” and credit being linked by about 5000 BC: “Dates, olives, figs, nuts, or seeds of grain were probably lent out . . . to serfs, poorer farmers, and dependents, to be sown and planted, and naturally an increased portion of the harvest had to be returned in kind.” In addition to fruits and seeds, “animals could be borrowed too for a fixed time limit, the loan being repaid according to a fixed percentage from the young animals born subsequently.”

Today, basic principles of the Interest component remain the same. However, its implementation and methodology has undergone a sea change. Banks and financial institutions are engaged in an interest rate war to woo more and more business through depositors as well as borrowers.

What are the main Interest options available to borrowers?

It is imperative for individuals and organizations to understand different aspects of rate of interest & their impact on them, especially at a time when they are borrowing money from banks and financial institutions. Bank branches remain flooded with customers seeking access to loans to negotiate their various needs. And, of course, liberal loaning has revolutionized businesses and peoples’ lives.

However, it has been observed that in a rush for obtaining a loan, the borrowers don’t evince any interest in understanding different aspects of a loan process. Mostly, they don’t work out the cost of their loan – the rate of interest and its application on the loan amount.

Usually there are two options to charge interest on loans – fixed rate and floating rate option. In fixed rate options, usually the interest rate is fixed for the entire period of the loan. It’s not linked to the market conditions and remains stagnant throughout the currency of the loan. However, this fixed rate option too can change.

In the case of a floating rate loan, the interest rate is not fixed. It is linked to the MCLR (Marginal Cost-based Lending Rates). Marginal Cost of Funds based Lending Rate is the minimum lending rate below which a bank is not permitted to lend. Presently, the banks in line with the RBI directions are using the Repo Rate Linked Lending Rate (RLLR). Under the RLLR model, any change in the repo rate has a direct impact on the interest rates.

For example, if the RLLR is hiked, the interest rate on the loans will also go up and subsequently EMI will also go up. However, if the RLLR goes down, the interest rate on the loans will also go down. The bank fixes a spread between BR and floating rate while sanctioning a loan.

Precisely, the floating rate option means that the rate of interest on the loan will fluctuate, up or down, depending on the market condition.

Source Google News