Understanding Interest Rates

There’s a lot of talk these days about interest rates. When will the Fed (the Federal Reserve Bank) raise the interest rate, and how high will they raise it when it does? Of course, when the Fed raises or lowers an interest rate, it’s only dealing with one in particular – the rate that banks have to pay when they borrow from one another. But every time the Fed does adjust this “prime” rate up or down, it affects the rest of the interest rates in the whole economy.

What is an interest rate, anyway? In its simplest terms, an interest rate is the fee that is paid by a borrower (debtor) for the use of money it has received from a lender (creditor). Most often the interest rate is expressed as a percentage of the amount of the loan (principal), generally for a fixed time period, most often a year. Different interest rates exist because different types of loans impose different levels of risk for the creditor, and different debtors have disparate abilities to be able to pay back a loan in a timely manner.

It would be nice if interest rates were actually that simple. But the truth is, there are several different types of interest rates: real, nominal, effective, annual, etc. The differences between these rates may seem overly technical to the uninformed, but lenders have been taking advantage of the public’s general ignorance of their distinctions for years in order to increase the actual payback on their loans. Here is a brief explanation of the different types of interest rates:

The “nominal interest rate” is fairly straightforward. If the nominal rate on a loan is five percent, a borrower can expect to pay $5 of interest for every $100 borrowed.

The “real interest rate” is slightly more complex, as it factors in inflation, which is the term that describes the devaluation of money over time. The real interest rate measures the lender’s loss over time due to inflation, when his money is no longer in his hands, but is “owned” by the borrower, and he can’t invest it anywhere else. For example, if money is lent at five percent for a year, but the inflation rate is three percent, then the real interest rate on that loan is two percent.

Another type of interest rate is the “effective rate.” This rate takes the power of compounding into account. For example, if a bond pays six percent a year but compounds semiannually, then the interest gained over the first six months is added to the principal. So, while the interest rate remains the same for the second six months, it is paid on the new, higher amount. Therefore a six percent rate on a $100 bond, compounded semiannually, has an effective rate of 6.09 percent.

Finally, there is the “annual percentage rate” (APR), which is expressed as a single percentage number that represents the actual yearly cost of funds over the term of a loan, plus any fees or additional costs associated with the transaction. It will always be higher than the nominal rate.

The chief advantage to knowing the difference between these different rates is that it allows consumers to make better decisions about their loans and investments.


What is Soft-Story Retrofit and Why do San Francisco Buildings Need It?

A soft-story building is a multi-story edifice which has housing on the upper floors, but open parking, wide doors or windows, a large unobstructed commercial space, or any other openings on the ground or lower floors, where a shear wall – one that would normally be required for structural stability – is absent.

A building would be classified as having a “soft story” if that level is less than 70 percent as stiff as the floor immediately above it or less than 80 percent as stiff as the average stiffness of the three floors above it. Soft-story buildings are vulnerable to collapse in a moderate to severe earthquake because the soft-story level is inadequately braced and, thus, less resistant to lateral earthquake motion. It is the “weak link” in the building’s chain whose failure can cause an entire structure to collapse under the stress.

It is estimated that “soft-story failure” was responsible for almost half of all homes that became uninhabitable after the October 17, 1989, Loma Prieta earthquake, which also caused 63 deaths and 3,757 injuries in the affected areas of Northern California. Should another major quake rattle the San Francisco area, approximately 160,000 additional soft-story buildings potentially could be destroyed.

In a proactive move designed to prevent such a catastrophe, San Francisco’s Department of Building Inspection created the Mandatory Soft Story, or Seismic, Retrofit program in 2013. The multi-year, community-based effort is designed to ensure the safety and resilience of all older, wood-framed, multi-family buildings that were constructed before 1978, when modern code changes were adopted, and that may suffer from a soft- story condition.

In the City by the Bay, some 4,300 buildings with five or more residential units on two or more stories have been identified as having a potential soft-story problem and it is estimated that up to one quarter of these buildings would be expected to collapse in a moderate to severe quake. With retrofit, however, collapses could be reduced to less than one percent. According to the ordinance, these buildings are required to be screened by a structural engineer to determine if they require the requisite retrofitting. Buildings that do not comply will be issued notices of violation.

While seismic retrofitting of these buildings has been estimated to cost between $60,000 and $130,000 per building in direct construction costs, and take two to four months to complete, the number of lives that could be saved in the event of a major earthquake is incalculable, considering that these buildings house nearly 58,000 people, and their 2,000 businesses employ another 7,000.

Seismologists predict a 63 percent probability that the Bay Area will experience a magnitude 6.7 earthquake in the next 30 years. In order to prevent as many deaths and injuries as possible, it is imperative that all identified, soft-story buildings be retrofitted as quickly as possible in order to withstand the next destructive, seismic event.