Debt Part 2 - Do you know how interest rates work?Submitted by Helkie Financial & Insurance Services Inc. on July 15th, 2018
We're in a historical time where interest rates are at an all time low. Or should I say we were? The average consumer may or may not understand how interest rates impact them. We hear about it, but do you know how it affects you? The cost to borrow money was almost nothing in the last several years. Here's an example: You borrow $1000 and the interest rate is 2%. Simply put, it will cost you $20 to borrow the $1000. Bargain, right? Maybe if you pay it off fast. Low interest rates make carrying or accumulating debt seem like a great idea – right? WRONG!!!!
So if interest rates go up to 4%, no big deal right? Now that same $1000 is costing you $40. What if you don’t pay it back in the first year? That interest rate applies as long as you owe the debt, it compounds and accumulates. Similar to compound interest when you save, debt compounds. So, if you don’t pay this off in year one, it will cost you another $40 next year – and so on. Except that it is 4% on $1040 now – $41.60 in interest. So that $1000 item has now actually cost $81.60, if you pay it back in year two = $1080 actual cost for that item. Now apply that to a credit card with an average of 18% interest rate. This would be $180 per year for $1000 if it is not paid off. Not such a bargain.
What if the debt was $10,000 at 18% Interest. $1,800 in interest each year. And so on…
All debt arrangements (credit cards, loans, lines of credit, etc.) have different terms. Some don’t allow you to pay the debt back in a short period of time. Some have penalties. Some charge more to repay monthly than they do annually. Do you know your terms? Do you know your interest rates? Most importantly – what does it really cost? Can you afford it? Do you need it or want it?
Knowing is power!