Jaez: this is just not how it works, economically or sociopolitically. Several points:
This is the fundamental principle of economics, the Peano's axiom of
finance if you will, which says that it is worth more to have money
today than the same amount of money at a future time. There are many
reasons for this, principally that money can be turned into more money
(invested), and that in a healthy economy money tends to become less
valuable if you leave it sitting around stuffed in a mattress (this is
called "inflation"). Even more fundamentally, there is utility
in having money in the present: it can be turned into food, clothing,
shelter, entertainment, or other nifty things. If you do not believe
in the time value of money, for example, you should be willing to
forgo your salary over the next 30 years and receive it all instead in
a lump sum in 2031.
You are probably not willing to do that, because you will be getting
hungry before then.
Whatever the reason to a specific lender and borrower, though, money has time value, and like anything else that has value the only way we know of to control supply and demand is with price systems, hence the interest rate is born.
2) "It means the loaner is richer than he was at the start"
Not necessarily. The lender is nominally richer, but can in fact
be poorer in real terms. Let me explain how lending and borrowing works.
Lending is based on three factors:
- Rate of return: The risk-free rate is a theoretical interest rate paid by a
borrower with no probability of default ('default' = not
paying the loan back, for whatever reason.) There is no such thing,
of course, but the closest benchmark in the financial markets are
U.S. government T-Bills and Treasury Bonds. For many purposes,
you can think of the risk-free rate interchangably with the time value of
money, ie: if the risk-free rate is 4% annually then $100 today is
worth $104 a year from now, or (and this is the important part)
receiving $100 a year from now is worth $100/$104 = $96.15 today.
(This is called discounting). It's worth that *because* the opportunity cost of lending it is that high: if you held onto it and bought a T-Bill, you'd have that much later at essentially no risk. The risk-free rate tends to be low,
which explains why the rate of return on things like T-Bills is so
low in comparison to other instruments.
The risk-free rate has to be considered together with the inflation
rate, though, since while your money is busy being turned into more
money it is also losing buying power. So if money is invested at the
risk-free rate at 4% but the inflation rate is 5%, that money is
deflating at 1% per annum. So part of what you're charging for when
you charge interest on a loan is compensation for getting back the
deflated principal at some future time: If I lend you $20 to refuel
your car and by the time you pay me back it costs $30/tank, then I'm
- Credit risk: All of the above is basically it if you are
lending to a super-stable entity like a (well-established, politically
and financially stable) government. But what if you are lending to a
small business, or to a 25-year-old buying a sports car, or to an
internet startup? Some of those loans are going to be riskier than
others. A $100,000 loan to someone who goes bankrupt and does not pay
you back is worth $0. Thus the value of the loan should actually be
multiplied by (1 - p), where p is the probabilty of default. The rate
of interest above the risk-free rate is compensation for taking on the
risk of losing the whole loan. If you're a lending institution like
Fannie Mae you have armies of statisticians that estimate these
things for you, and you have a large enough portfolio that it behaves
like those statistics, so you can not lose your shirt (this is called
a "portfolio effect").
- Liquidity: This is in some sense back to the time value of
money. Liquidity measures how quickly and easily something (like a
loan, or a bond, or a stock) can be turned back into cash. Most loans
are not very liquid: As a lender I can't realistically show up at the door of
the nice 26-year-old couple that borrowed $300,000 last year to buy a
3-bedroom house and ask for my money back. I can under
certain circumstances sell their loan to someone else, however.
The less liquid the loan, the higher the interest rate (since lenders on the balance prefer
loans they can turn back into cash) that gets charged.1
All these things figure into how much a lender could realistically charge for a loan and hope to break even. The real 'usury' of the loan, the interest rate charged above and beyond all of this simply for the privilege of borrowing, is called a 'spread' and is usually quite small. Part of what makes it small is that there are efficient markets where lenders have to compete.
3) Upfront fees:
If the project I am borrowing money for is worthy, why should I
have to pay more than I borrow? If for example it is personal, then
why not pay an upfront fee, with penalties for late payment instead of
the torture of interest? That way at least I know there is a cap to
how much I have to pay back should things go badly wrong.
First of all this exists: it is called a zero-coupon loan. It exists most
often in the bond markets (where it is just called a "zero"). If you
think about it a second, an appropriately-sized upfront fee can be
made equivalent to n-annual interest payments over a given time
period. Example: if the risk-free rate is r, then a 5% annual loan on
$10,000 over 2 years would have payments of $500 over the next two
years. But the present value P of those two payments is P = 500/(1+r) +
500/(1+r)2. Any lender that can earn money at the rate r with no risk should be indifferent between charging a given interest rate and an upfront payment of all of the future payments discounted at the risk-free rate. It turns out, however, that most people prefer to spread out the payments because that's why they're borrowing in the first place. But this does exist in a hybrid form: when mortgage buyers pay 'points' to reduce their interest rate, this is exactly what is going on.
4) Justice to the borrower:
Borrowers benefit greatly from loans: most people cannot afford to buy a home, go to university (in the U.S. anyway) or even buy a car without a loan. Creating efficient markets in these is a win-win situtation: the lenders win by making a small profit on their loans. (If they're good at it: you don't have to look hard to find banks with an excess lot of loss-making loans on their books.) The borrowers win by having access to capital they would not otherwise have, and are willing to pay a premium for that access.
1Organizations like Fannie Mae and Sallie Mae make markets in things like mortgages and student loans in order to provide some liquidity, which ultimately reduces the cost to the buyers.