"Interest is a fee paid on borrowed assets. It is the price paid for the use of borrowed money, or, money earned by deposited funds. Assets that are sometimes lent with interest include money, shares, consumer goods through hire purchase, major assets such as aircraft, and even entire factories in finance lease arrangements. The interest is calculated upon the value of the assets in the same manner as upon money. Interest can be thought of as "rent of money". For example, if you want to borrow money from the bank, there is a certain rate you have to pay according to how much you want loaned to you.
Interest is compensation to the lender for forgoing other useful investments that could have been made with the loaned asset. These forgone investments are known as the opportunity cost. Instead of the lender using the assets directly, they are advanced to the borrower. The borrower then enjoys the benefit of using the assets ahead of the effort required to obtain them, while the lender enjoys the benefit of the fee paid by the borrower for the privilege. The amount lent, or the value of the assets lent, is called the principal. This principal value is held by the borrower on credit. Interest is therefore the price of credit, not the price of money as it is commonly believed to be. The percentage of the principal that is paid as a fee (the interest), over a certain period of time, is called the interest rate." 
The Evil Interest Fallacy
Is interest evil? Many people who have become disillusioned with capitalism, see quite rightly that investment interest is how wealth gets funneled to those who already have the most. It is easy to think that interest is evil and must be done away with.
In the United States, our money is created by private companies lending it into existence and charging interest on it. Clearly this is not fair. But even worse, many people argue, is that the interest can never be repaid because it is not created as part of those loans! This argument is so popular that the search phrase “interest can never be repaid” gets 115,000 hits on Google.
But (1) interest is not evil in itself. And (2) the “interest can never be repaid” argument is seductively righteous and simple, but wrong.
Interest is not evil
People think interest is evil because the wealthy investor earns interest simply by being wealthy. The investor is not producing any useful goods and is not contributing any useful labor to society. Our current economic system rewards the investor for being wealthy much more than it rewards people for being productive. For example, let’s say Bill Gates earns $5 million a year doing productive work and let’s say, generously, that that amount is complete and fair compensation for all of his work for the year. In the same year, Mr. Gates’ $50 billion brings in another $5 billion or so in income (a thousand times as much as his paid work). Since we agreed that $5 million was fair pay for his actual work, the $5 billion of “unearned income” (as the IRS calls it) must be undeserved income.
When I gave this example to a colleague recently, he argued that Bill Gates might actually deserve those billions because of the great value that he has already given the world. I could argue against that, but the objection is missing the point. Surely there is SOME amount that is fair pay for his or anyone’s work. Then whatever investment income he gets beyond that fair amount is clearly unfair pay.
Here we come to the root of the problem. What triggers our moral outrage is the unfair pay, not the interest per se. What rankles is not that billions follow billions, but that someone is profiting unfairly. And perhaps, less obviously, that the rest of us are unfairly missing out on that profit.
The common good bank design rights this wrong by dedicating all profits to the common good. unpayable debt fallacy
The "Unpayable Debt" Fallacy (from http://vimeo.com/raam)
the “interest can never be repaid” argument is wrong
Like many attractive fallacies, this one has an element of truth. The error and the partial truth have to do with the fact that money is not designed to go just one way. It circulates.
Figure 1 shows a diagram of of how money is created and how at first it looks as though the interest is unpayable, since it never gets created. In the diagram, money paid as interest goes to the bank and never leaves except as additional loans. This makes it look as though interest is incompatible with sustainable economics.
The true situation is more complicated. In figure 2, I have added a crucial third party: the investors.
Most of the interest and fees that the bank receives goes to pay the expenses of operating a bank: salaries and wages for employees, utilities, legal fees, taxes, and so forth. Money for these expenses gets returned to the circulating money supply.
The remainder of the bank’s income is profit.
unpayable debt fallacy correction
Mutual banks (also called “cooperative banks”) and credit unions do in fact generally hold onto and relend their small profits — otherwise they cannot grow. This is a problem, but not a big one.
The vast majority of financial assets are held by stock-based banks, which are required by law to maximize profits. Profits go to the owners of the bank, the investors. The investors also receive profits from investment in other businesses.
Here again, it rankles that the investors are receiving all those profits without lifting a finger. But beyond our vague sense of unfairness, there are two very real problems.
Problem A: Investors typically receive more profits than they spend. This means that the buck stops there. The money stops circulating. It piles up.
Conceptually we can divide people into two groups:
(a) Investors — people who have more money than they need (and therefore have some extra that they can invest) and
(b) Non-investors — people who have less money than they need.
When investors receive more profits than they spend, the result is that people in group (a) who already have more money than they need end up with more and more of the money, leaving less and less for people in group (b) who already have less money than they need. This is a big problem. It is the root cause of poverty.
Problem B: Investors, being wealthy, typically spend and consume more than the average person. The big spenders are the worst offenders, but they are not alone. In fact, in the United States most of us — rich or poor — consume much more than we produce. For example, my family and I live on what is considered a “poverty level” income. And yet it would take us many years to produce for ourselves the goods and services that we blithely consume each year. This too is a big problem. It means that some people somewhere are working very very hard to produce the goods and services that we consume.
The Common Good Bank Solution
unpayable debt fallacy CGBs
Figure 3 shows how the common good bank system solves both problems, creating a sustainable economic system. Common good banks will charge interest, but the profit from that interest all goes back to the community as grants to schools and other nonprofit organizations. The money keeps circulating. None of the profits go to enrich individuals.
In fact, communities must dedicate half their profits to advance the common good outside their community. Wealthy communities will likely have larger deposits, larger loans, and larger profits than poor communities. So the wealth will gradually get distributed more evenly.
To clarify how interest can be repaid even though it is not explicitly created when the principal is lent into existence, here is an example:
Example of Paying Interest With No Problems
Imagine a world with just two people, Al and Betty, and one nonprofit bank.
Betty is a farmer. Al is a bank teller and tool-maker.
At first there is no money. Then one day Betty borrows $100 from the bank, to buy a plow from Al. The bank lends the money into existence, with interest of $1 per month. Betty plans to pay $11 a month, so that the loan will be paid off within ten months.
At first it looks as though Betty will only be able to pay back $100 (without interest) because there is only $100 in circulation. The interest will be unpayable. But since the money circulates, both principal and interest can be paid, without creating additional money. Figure 4 shows how it goes.unpayable debt fallacy Example
The first month, Al pays Betty $11 for food. Betty pays the bank $10 plus one dollar in interest. The bank pays Al $1 in wages and retires $10 of the debt. This leaves Al with $90. Betty and the bank each have nothing.
The second month, these transactions are all repeated, leaving Al with $80. The transactions are repeated again the next month, and so forth, each month leaving Al with $10 less.
In the ninth month, just after Al receives his pay, he notices that the world is about to run out of money, so he decides to spend his last $10 on food. Betty immediately pays off the loan. No additional interest is due and Al has already been paid for the month. The bank retires the final $10 of the loan. No money is left in circulation and there are no outstanding debts.
In this example, the bank makes no profit. If the bank does make a profit, say by paying Al only 50 cents a month, there is still no problem as long as the bank is a common good bank. The profits simply go to a nonprofit that (for example) pays Betty and Al to create works of art. The money stays in circulation.
In the common good bank system, interest is not evil and causes no problems. In the common good bank system, interest contributes to economic justice and sustainability. 
- Wikipedia article on Interest
- Common Good Bank article http://commongoodbank.com/2009/10/general/the-evil-interest-fallacy