## Sunday, June 13, 2010

### Interest Rate Vs True Cost of Interest

Rate versus Cost

There are multiple ways of calculating interest.
I don't know them all, but some are compound,
simple, average daily balance, amortized,
minimum monthly balance, to name a few.

The way interest is calculated makes a huge difference
to the actual costs associated with a loan.
For instance when you purchase a car for example
the interest rate might be 5%,
cost of car \$25,000,
monthly payment \$575,73,
with a 48 month term.

So what is 5% of a monthly payment \$575.73?
Most people think this is what they are paying.

However the first payment will be divided into
\$471.57 towards principal and
\$104.17 towards interest.
So that means you are actually paying
18.09% interest that month.

After 13 payments you have paid \$25,000 -
\$18,714.02 = \$6,285.98 in principal payments
plus \$1,198.54 towards interest
equals a total of \$7,474.52 in payments.
The percentage of interest volume you have paid
the lender is still 16.01%.

So for the first 13 of 48 months you are really paying
an average of 17% interest on a 5% loan.

If you do pay the whole loan back over 4 years
you will actually pay \$2,635.15 in interest charges
which is 10.54% of \$25,000 on a loan charge rate of 5%.

The national average is that most people return
their vehicle for a trade in before they have paid
off their loan, so during the last year or two when
you would be paying mostly principal payments
you start a new loan all over again beginning
with the higher percentage going towards interest.

The interest rate does not matter as much as the cost
you are really paying.

Once you pay the lender your money for the car,
that money has now gone, never to be seen
or used by you again. So now you have to start
all over again, borrowing more for the next thing
you want.

What if there was a way to recapture not just the 17%
or 10.54% interest charges but also the principal so it was available for
you to buy the next car with when you are ready for a new one?
Would it be worth it to you to learn how?
How many investments offer 10.54 or 17%
returns guaranteed?

We help people Simplify their Finances
by reducing the effective interest rate on all loans.