Interests on debts

Why pay interests on debts?

When you borrow something (tool, car, house), you pay rent to compensate the owner for not having the usage of the item.  When the item is money, the rent is called interests.

How are interests computed?

Interests are a percentage of the loan amount.  It is a function of the duration of the loan. Where a rent is usually expressed in months, the interest rate is generally stated on a yearly basis.  Example: 100 EUR at 12% yearly interest for 6 months costs 100 * 12% (yearly) / 2 (half a year) = 6 EUR.

Does a creditor get rich with interests paid on debts?

During the sales process, the seller and the buyer agree upon an ultimate date of payment (for instance 30 days).  The creditor has already invested money to produce this item or service.  He will reinvest the price paid into producing new products or services.  Should he not be paid on time, he will need to find money elsewhere. This means that he’ll need to get a loan, which will entail a cost (even the company capital is a kind of loan that needs to be paid for). But there is a limit to the amount of money that a company can borrow. And what is allocated to compensate unpaid bills cannot be invested in a more productive way. A creditor gets in fact poorer when the payment of his sales is delayed.

Delayed payment cannot turn into a debt spiral for the debtor.

A banker (the professional for loans) will limit his risk by gathering information and will probably require a guarantee before to make a loan. The unpaid creditor does not benefit from such tools.  In this perspective, the interests on unpaid bills must be high enough to deter the debtor from using such devious means of financing himself.  Besides, such debtor risks entering a debt spiral.

More: costs of debt collection

Updated 18/8/2016

Definitions provided under this section refer to the Belgian situation; unless specified otherwise. The texts are meant to summarize concepts in daily language and should not be considered as comprehensive or definite. We welcome suggestions for modifications or additions at glossary@tcm.be.