How “Time Value Of Money” Can Affect Repayment Interest Rate?
Concept Of Time Value Of Money
Time value of money (TVOM) is a concept to measure the value or particular amount of particular currency over the time. It is derived from the fact the money is not static and changes its value over the time. For example value of today’s $100 may be equal to the value of $50 or less after one or two years. This change can increase or decrease the value of the money on the basis of infatuation or economic condition of the country. In other words, you can’t enjoy the same purchasing power after one or two years like you do today. It is because of the known fact that the value of money will likely to decrease over the time.
It is calculated with the algebraic expressions that shows the future value of the present sum. There are several basic equations through which one can calculate the value of money over the time.
Interest Rate Of Loan
Interest is the cost that borrowers have to pay for lending the particular amount for the specified time period. The interest rate charged by the lenders is determined on different factors like risk involved in the lending, borrowers repaying ability, etc. Every lender charges different rates as their process to calculate the risk is different from the other.
In case, borrower has history of bankruptcy or other blemished marks, then he/she will get the loan amount at high interest rate. But if loan seeker has the long history paying bills and repayments on time, steady income, etc. then it is more likely they will get the loan at lower interest rate.
Affect Of Time Value Of Money On The Interest Rate
Borrowing money means you are taking money now with the agreement to return small amount with small installments over a time. In this time period, value of money will be decreased that put the lender is loss side. So, to cover that loss lenders check the TVOM over the repayment period and add the particular percentage in the interest charges so they won’t be on the losing side. They calculate both TVOM and probability of default in order to come on the particular interest that to be charged on the loan. That is the reason; interest rate varies from borrower to borrower.
It is important to note that if you repay the loan amount before the due date then you can expect to earn the interest because the time value of money is calculated for longer period. You can ask lender regarding their calculation style in order to save money on interest if paid loan early.
Time values of money affect the interest rate quite heavily as lenders are offering money to make profit and not loss. So, do check the interest rate carefully before availing any loan deal. Comparing rates of different lenders would be helpful in getting loan at rate that comes within your budget.