In Finance, what is Personal Interest?

In finance, personal interest refers to the interest paid on personal loans. In other words, it is the cost of borrowing money for personal purposes. The interest charged on personal car loans, credit cards, or person-to-person loans, for example, is usually personal interest.

The value that personal interest takes for a given loan is usually determined as a percentage of the principal of the loan. Often this percentage is calculated on an annual basis, and is therefore known as an annual percentage rate (APR). Personal interest rates may also be a flat amount or it may include other finance fees.

There are two main ways of determining personal interest — simple interest and compound interest. Simple interest loans apply the interest rate on the unpaid principal only. That is, if the loan amount is $5,000 US Dollars (USD) with a 5% APR, the borrower will owe $5,500 USD if she hasn't paid anything back after two years. Compound interest loans apply the interest rate on the unpaid loan amount — unpaid principal and unpaid interest. In this case, if the loan amount is $5,000 USD with a 5% APR, the borrower will owe $5,512.50 USD after two years.

Personal loans may come in two forms — secured personal loans and unsecured personal loans. A secured loan requires another asset to protect the lender in the case of default by the borrower on the loan. An unsecured loan doesn't require the backing of some other asset to reduce the lender's risk, however, these types of loans usually come with higher personal interest rates instead.

The tax rules of various countries deal with personal interest differently. In the US, for example, personal interest is not considered a deductable expense. The exceptions to this rule are costs associated with one's primary residence, a second home meeting certain requirements, and student loans. These types of loans produce deductible interest, which can reduce one's tax liability. Many consumers choose to set up home equity lines of credit to pay off consumer debt, allowing them to deduct the interest paid.