Interested in interest?

What you actually pay (or receive) in interest is seldom what you think. Calculating interest payments would be lot less complicated if people used “simple interest” (which would just be a straight percentage) – but almost NOBODY does. Compounded, annual percentage rates (APR), and amortized values are usually quite different from what most people believe they are agreeing to.

The U.S. Government pays the Federal Reserve Bank 6% interest on every (Dollar) note it receives – which is part of the reason the “national” debt continues to increase and can NEVER be repaid. If you bought a house with a bank loan of 6% and payments of $1,100 per month, only a little of $200 would be applied to the principle (owed) and the rest would go towards interest – even though the interest rate is only “6%”!

Because a signed loan agreement for 6% interest is “amortized”, the actually daily interest (owed) is 22.5%! Your banker will claim that you are only paying 6% interest – while at the same time admitting that you are paying 22.5% daily interest on the loan. That may not make sense to you but they didn’t sell you a loan that made sense, they sold you loan you could afford to repay.

You don’t have to be a banker, an accountant, an attorney, or a mathematician to buy or use a Simple Compound Interest Table book – containing various formulas for Future Value of a Dollar, partial payment of the Future Value of a Dollar, Amortization Tables, and a few other complicated formula’s for Future Values.

If you invest $10,000.00 at 15% interest your money would double in 7 years. If you take out a loan for $20,000 for 20 years at 7% interest that you would not be paying $1,400 in interest (or even $14,000 in interest) – but far more!

In the United States there is a law called the “Truth in Lending Act.” The Truth in Lending Act (TILA) of 1968 is a United States federal law designed to protect consumers in credit transactions, by requiring clear disclosure of key terms of the lending arrangement and all costs. Unfortunately, disclosure is seldom clear – and few consumers pay attention to the details of loans (and their repayment).

Banks and other lenders rely upon the rationalization that “you can afford the payments” as part of their sales technique. “At your income level you are quite capable of affording these payments. As a matter of fact you qualify for more money.” When in need of money for the purchase of a home, car, student loan, or even credit cards people often overlook the real amount of repayment for the ease of access to cash to make purchases.

Repayment terms may be disclosed (in the small print), but even when they are read, they are seldom (really) understood – nor do they need to be accepted. TERMS are ALWAYS more important than RATES or even COST. Any (financial) paperwork you sign is a legally binding (commercial) contract – that can be modified or amended prior to signing. A lender may choose to not accept a revision, but it is certainly possible to cross out or rewrite any portion of the agreement before signing and submitting it. IF they process, accept, and/or countersign it, then the terms will legally be those that YOU have chosen, not them. You could also write on the back of your checks that a lender’s acceptance, endorsement, or deposit of whatever amount you are paying constitutes their agreement that your debt/account/balance will be considered paid in full (and you would win in court if they later protest). The point is that what is printed on legal and financial documents can make a big difference and that if you don’t pay attention, you may be paying something else (like more money than you need to).

Below is an Amortization calculation for payment amount per period. There are formulas for nearly every borrowing situation you can imagine (formula’s for Rate per Period, Payment amounts with Balloon Payments, etc. etc.).

The formula for calculating the payment amount per period is:

A = P*r(1+r)n/(1+r)n-1 where

A = payment Amount per period
P = initial Principal (loan amount)
r = interest rate per period
n = total number of payments or periods

Example: What would the monthly payment be on a 5-year, $20,000 car loan with a nominal 7.5% annual interest rate (with an original price of $21,000 and a $1,000 down payment)? The answer is (A) $400.76 per month:

P = $20,000
r = 7.5% per year / 12 months = 0.625% per period
n = 5 years * 12 months = 60 total periods

© 2010, Oren Pardes. All rights reserved.

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