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Why We Pay Interest

The Origins of Interest

The first appearance of the concept of interest goes back to the days of the ancient Sumerians.  It was based on the concept that if you had a herd of cattle (let’s say 100 head), and you lent that herd of cattle to someone else for a year, you would expect that at the end of the year you would get your 100 head of cattle back plus some extra cattle, because of new births.  That extra amount was interest.

We see roots of the word “interest” in the Sumerian language.  The word for interest is “mash”, which was also the word for “calve”.  For the Greeks, the word was “tokos” which refers to the “offspring of cattle”.  And for the Egyptians, the word is “ms”, which means “to give birth”.

In a society like the ancient Sumerians, where the size of your flocks and herds indicated the size of your wealth, it is easy to conceptualize that natural occurring offspring (interest) would add to your wealth.

The Early Years

In more modern America, we are familiar with the concept of raising or lowering the interest rate to stimulate the economy or avoid inflation.  But this idea is not so new.

In England, during the 18^th century, the economy also reacted to the amount of interest charged.  Normally, interest ran at about 4%.  When the rate was lowered, business increased.  When the rate was raised, business slowed down.

In the Roman days, interest rates were similar to our current America.  Normal interest rates were at about 12%.  When they wanted to get things moving, they would lower it to about 6%.  For risky loans, they would raise the amount charged to 24%.

Good or Evil

In some circles, the concept of making money from loaning it out is sinful or un-natural.  The Ancient Greeks struggled with the concept of interest.  Philosophers such as Plato and Aristotle felt that money was “barren”, and that no offspring can arise from something that is barren, therefore no interest should be collected.  But this may have stemmed from the fact that in early Greek days, there was no imposed restriction on the amount of interest that could be charged on a loan, therefore greedy creditors got very rich.  So, to counteract this, they banned interest.

Over time, as the Greek empire gave way to the Roman empire, the Roman’s reinstated interest, but ensured that “gouging” did not occur, by regulation and establishing specific rates.

Hmm…What to call it

To stay within the law (or avoid the law, depending on how you look at it), various types of interest have been established over the years.  For example, to skirt the issue of charging a certain interest rate, some lenders have charged a “fee for service” which eliminates the term “interest”.  The end result is the same for the borrower, it’s just called something else.

Another way to circumvent the term “interest” was to charge a penalty fee for late repayments of principal.  The penalty amount was agreed upon before time, and it was also agreed that the borrower would “breach” the contract by making a late payment, therefore insuring that the lender received his penalty payment, or “interest”.

Sometimes the “interest” would be collected as a fee for lost opportunity cost.  It was reasoned that a borrower really needs that money today, and they will promise to pay back more in the future after making profits with the money.  The lender receives a payment because of his lost opportunity cost.

Another thought is that if the money loaned was for the purpose of investment, then the lender and borrower could agree on a compensation from the profits of the investment.  The exact amount of the profit sharing would be determined before hand.

Here to Stay

But one thing remains apparent, “interest” or whatever we have wished to call it through the ages, is here to stay.  In fact, for the most part, it’s always been with us, because there is always a cost for the use of money.

About The Author

Diane French is a successful freelance writer providing tips and advice for consumers on mortgages, personal loans and equity loans.  Her many years of mortgage industry experience have helped others understand the business.

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