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A Closer Look at Loans

When Enrique arrived at the school cafeteria at lunchtime today he found himself in a bind. He had forgotten his lunch money on the kitchen table at home. He was hungry. He considered going home to get his money, but decided there was not enough time. Instead, Enrique found Max, a friend from his math class, and asked him for a loan.

Max knew that if he gave Enrique lunch money he would have to put off buying the new shoes he had planned to buy after school. Max made a proposal, "I'll lend you the lunch money if I can have your dessert as interest." Max was willing to postpone his shoe purchase until tomorrow in exchange for dessert today. Enrique accepted the offer; it was worth giving up his dessert to get a loan to buy lunch. Enrique and Max were both pleased with the transaction.

Do you remember the last time you borrowed money from someone? For what did you borrow? Did you have to pay interest?

Have you ever loaned money to someone? To whom did you lend? Did you charge interest?

A loan is a sum of money provided temporarily on the condition that the amount borrowed will be repaid, usually with interest. When people borrow money, they are using money that belongs to someone else. The price or fee for using someone else's money is interest. You can think of interest as a way to compensate a lender for giving up other uses of the money for a time. For Max, dessert served as interest, but for most transactions interest is money. The amount of interest on a loan is often expressed as an interest rate, such as 5 percent, which is the percentage of the principal that must be repaid (in addition to the principal) over a specified time period.