Gather Little by Little

Johnny Carson once said, “Scientists have discovered a powerful new weapon that leaves buildings standing, but destroys people . . . it is called the 17% interest rate.” Another famous quote about interest may or may not have been uttered by the famous physicist, Albert Einstein, who was once asked about the most powerful force in the universe and answered: “compound interest”.

I always understood the math side of interest, but it has taken me many years to fully understand the impact of compound interest. The more I understand compound interest, the more I hate debt. Just think about of how much money a family could have save over time if they never financed a purchase. What a novel concept – just save up the amount needed before making the purchase! My family is not drowning in debt, our credit is good and we have almost never paid credit card interest, but it makes me sick to add up the amount of money we are throwing away – just because we could not wait:

• House Payment: $625*
• HELOC: $130*
• Car Payment: $310*

*numbers are pseudonymous

How much interest?

Of that $1,065 in monthly finance payments, only about $300 is being applied to principal! Could we have gone without a house for a few more years? Certainly. Could we have gotten by for a couple more years with a less expensive car? Of course. Look at it this way, if the price tag on our car was $17,000. And we could have saved the amount equivalent to our car payment each month before purchasing the vehicle, we would have had to save for 55 months, give or take. By getting the car right away,  we will now be paying for 72 months – almost two years longer than if we had saved up – and the car probably will not even last that long.

The HELOC is an even worse deal. If we continue to make payments for the entire term of the loan, we will have given the mortgage company almost three times the original loan amount! Makes that new roof look mighty expensive.

Total payments

From now on, when my wife and I discuss taking on debt to pay for things that we think we need, we are not going to consider the number on the price tag, but rather, we will use the number commonly known as “total payments”. This is the number that you get when you add the principal to the amount of interest that you will pay over the life of the loan.

Some examples:

A $20,000 car at 7% APR will actually cost $24,550 over 72 months.

That $10,000 home equity loan to remodel your kitchen or – heaven forbid – take a vacation to Disneyland? At 8% and amortized over 15 years will cost you $17,760.

That house that you so desperately need to “own”? The one with a great purchase price of $190,000 and a low rate of 5.125%? It will cost you $372,427 over thirty years.

I don’t know about you, but after we lick our current debt, we don’t plan to sign any promissory notes anytime soon. A used car is fine by us and I do not have a problem with renting for a long time. Live is too short to spend so much time and effort trying to come up with the interest.

Photo by omar omar