# What is the difference between the rate of return and the interest rate?

An interest rate represents how much interest must be paid on the principal amount of a loan.

The difference between the rate of return and the interest rate is based on the nature of the returns on investments and the interest paid on a loan. Rate of return refers to a value that indicates how much return is generated based on the initial investment made, also called capital. This rate is expressed as a percentage and is based on capital and annual profitability, which is the amount earned over a year. An interest rate, on the other hand, is based on additional amounts paid on a loan that are not part of the loan repayment itself.

It is often easier for someone to understand the difference between a rate of return and an interest rate by first understanding what each of these terms means. The rate of return on an investment is the percentage of loss or gain generated by an investment. This amount is based on the initial investment, or capital, and the amount recovered over a given period, such as one year for an annual rate of return.

The rate of return can be calculated by subtracting the capital from the return and then dividing that amount by the capital to determine the rate. For an investment of \$100 US dollars (USD), for example, and a return of \$120 USD, capital is first subtracted from the return to determine growth of \$20 USD. This amount is then divided by the capital, for a rate of return of 0.20 or 20%, which indicates the rate of return on that investment for one year.