Loans and moneylending are one of the oldest known professional skills, with roots that date back to Antiquity. One of the first acts attributed to Jesus in the New Testament is kicking over the table of the moneylenders in the Temple of Solomon and flogging them with whips.
In modern parlance, banks issue loans and expect to earn a surcharge on the money for its use. This surcharge is called “interest.” Most American consumers have a revolving line of credit with a credit card, which works like a loan, to get more details check with www.lm-sensors.nu.
Interest rates are calculated as “Annual Percentage Rate” or APR. If your credit card has an APR of 18%, over the course of a year, a $100 balance would accrue $18 in interest fees. Other types of loans work the same way – a mortgage is a loan for a large sum of money backed by a tangible asset (a house), and a payment term (15 or 30 years, typically) and an an interest rate (currently floating between 5% and 8% in most markets of the US).
All of the profit for the bank comes off of the interest rate. To figure out how much profit your bank is earning (or how much more you’re paying), there’s a simple rule of thumb called the Rule of 72: Divide 72 by the interest rate you’re getting in percentage points. At the minimum payment used by your lender, this is the number of years it will take for your interest payments to equal the amount of money you already borrowed.
Thus, if you’re buying a house worth $200,000 with a 30 year mortgage at 8%, you will accrue $200,000 in additional interest payments after 72/8=9 years of payments…and over a 30 year mortgage, you’ll end up paying almost $1,000,000 in interest payments over the term of the loan. This is one reason why there’s a thriving market in refinancing mortgages.
The same principle applies to credit card debt, auto payments, and student loan payments. By and large, paying money simply to own something is expensive. It’s vastly better for you to save up — in an interest bearing account, where the bank is paying you for the privilege of using your money — and pay for something in full up front, even with today’s historically low interest rates. The primary exception is purchasing capital goods for a business. If the asset you’re acquiring is earning you more money than the interest accrued each month, the loan is doing you as much good as it is your lender.