If you have ever been in debt, especially debt with a high interest rate, you know that it is not fun. Everyday you are losing money by owing it. An unfortunate fact of life is that it costs money to owe money. Further, debt and interest never take a break. They never sleep, never take holidays off, and don’t account for emergencies or life threatening illnesses. Debt is a scary thing but a lot of debt with a high interest rate is merciless.
The definition of debt is:1.something, typically money, that is owed or due. 2.the state of owing money.
What both of these definitions are lacking is the mention of interest. Most debt today (in fact, I would say pretty much all forms of debt) come along with an interest rate or a fee attached for using borrowed money. Typical consumer debt and mortgage debt have interest rates attached.
Think of it this way: If you ever owe someone or some entity money and there is an interest rate attached you are LOSING money each day that you owe them. Many credit cards and Paycheck loans have very HIGH interest rates. These rates can make paying back the loan very, very difficult because you are losing money quickly and adding more and more to your debt total. Avoid high interest rates whenever possible.
Albert Einstein said that compound interest was the “8th wonder of the world”. He exclaimed that it is the most powerful force in the universe. And he has been attributed to saying that the following formula was his greatest discovery.
What was it? It is called The Rule of 72.
When you invest money at X amount of a percentage rate you divide it into the number 72. Say you are earning 10% in a life insurance policy. If you take 72/10= 7.2. So if you invested $5,000 in an insurance investment policy it will become $10,000 in 7.2 years. This equation works on every debt or investment (no matter the amount) and no matter the interest rate. 72/X=Years until your money (or debt) doubles. (X= interest rate).
If you take a typical credit card with an interest rate at 14% and use the rule of 72 you will find that the banks doubles their money about every 5 years. And how long are the credit card companies designing your loan to take to pay off? Most payment plans are spread out over 22+ years on a credit card because the minimum payment is typically 1-3% of the total. Think about all those credit cards out there. If people aren’t paying them off the bank doubles their money on them about ever 4-7 years. That is a lot of money!!
Who wants you to be paying interest? Banks, investors, etc. because they lend out the money and make money back off of you. Rich/wealthy people figure out how to earn interest. They use money to make money.
Even low interest rates on a long term loan (such as a 30 year home loan) are insanely costly. If you have a 30-year loan on a $200,000 home with an interest rate of 5.5%, you will end up paying another $208,808.80, on top of the $200,000! Just at a 5.5% interest rate you will MORE THAN PAY FOR YOUR HOME TWICE!
I overheard a lady today while I was standing in line at the bank. The checker and her were discussing a loan. She said, “Soon it will be paid off. Immediately the banker said, That’s great, no more paying interest.”How she responded surprised me when she said, “No, I’m just waiting till it’s paid off so I can buy another truck.”.
Albert Einstein has been attributed as saying, “Those who don’t understand interest Pay it, those who do Earn it”. Clearly one person in the conversation at the bank understood the power of interest and the other didn’t.
So how do you earn interest? Check out this post here.
To recap. Debt and interest are usually constant companions. You are either losing money if you’ve borrowed it or gaining money if you lend it (the exceptions are the bad investments). If you are in debt you are losing money. To figure out how long it will take for an investment to double divide 72 by your interest rate and and you will find out. On the flip side if you want to know how long it will take your debt to double divide 72 by your interest rate to find that number.
Interest is something that should never be ignored. If you are investing you always want to know how much you are making on your investments. If you are borrowing, you always need to know how much it is costing you to borrow. When you start to realize how interest works, you will come to appreciate what Albert Einstein meant when he said “Those who don’t understand interest Pay it, those who do Earn it”.
What to know how to get out of debt? Check out this post here.
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