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Why are interest rates one of the key components in Finance and in Household Budgeting? This percentage number is how much a party or parties get(s) paid obviously but the real reason lies behind the scenes. See how Personal Capital can track your expenses in one location.
Having worked as a commercial credit analyst where my sole responsibility was to organize and interpret one’s financial situation, I have learned the power of interest rates.
This figure is unique because it can make one wealthy and can cause one to head towards the path of bankruptcy.
Imagine walking into your hometown bank for an automobile loan. You have had your eye on this new SUV for a while now and it is time to apply for a loan. The bank officer collects your information and determines if you are qualified or not. When she determines you have been approved and quotes you an interest of 4.6% you are assessing the impacts from the future monthly payment. To search for price quotes before you refinance, check out LendingClub's Auto Refinance.
Now put yourself in the shoes of the bank. Rather than shelling out monthly payments for repayment, you are receiving monthly reimbursements plus interest (making money from your money).
No matter which side of the aisle you are on, the Rule of 72 is an important calculation that is simple and one I recommend you know. While some of you don’t like math, with the calculator from your smartphone, you can quickly determine how fast it takes for your money to double.
(Read more about the Rule of 72...)
Why is it important to know this? Because when you are investing or saving, time is money! Simple as that. I like to simplify things and never complicate it if possible.
If I am looking for a place to put my money for a few years, let’s say 2 years, then the money will depreciate (go down in value) over time. For instance, a gallon of gasoline or milk was cheaper several years ago than it is today. This is the concept of Time Value of Money.
So investing and saving is our financial warfare to help reduce the risk of our money from decreasing in value. Obviously the higher the interest rate on our investment, the more money we save.
To my surprise years ago, I was amazed at the number of people who kept large amounts of money in their checking accounts. As of the writing of this article, the interest rate for a checking accounts ranges from 0.20% to 0.93%. By taking the Rule of 72, it would take someone 77 years to have their money in this account double.
Let’s pretend they had $60,000 in this checking account paying 0.93% annually.
Calculation: 72 years / 0.93 = 77.4
Most people are surprisingly comfortable with this because they do not understand the concept of Time Value of Money or inflation.
Inflation is a common enemy to the consumer dollar. The average annual inflation rate for the United States is 2.5%. The bank is paying you 0.93% but inflation is eating away approximately 2.5% of it. 0.93% - 2.5% = -1.57% you are averaging in loss in time value of money.
There are ways to combat this such as investing or loaning your money. Loaning your money, you may ask? Yes, with the advance in technology it has never been easier to loan money safely.
If someone would be willing to pay you 7% a year to borrow your money for 5 years, you could generate a monthly income of $839. This is repayment of the principal you loaned out plus interest. Now applying the Rule of 72, (72 / 7 = 10.3) it would take you slightly more than 10 years to double your $60,000 investment. Much faster than 77 years for money that sat in your bank account.
One of my favorite financial lenders and one that I really do use personally is SoFi. I've been with them since 2016 and love their service, their low competitive rates, and superior customer satisfaction. They offer personal loans, mortgages, and student loan refinancing. Even if you are just curious, it would be ideal to see what interest rate they charged compared to what you're currently repaying. You might be surprised you're overpaying. It doesn't hurt to get a quote with SoFi because they run a soft credit check.
If you don't know you're current credit score then I highly recommend you have it check by obtaining a Free Score Now at Credit Sesame.
If for whatever reason you have made a few mistakes in the past and looking to get a loan but your credit score is low, then try BadCreditLoans.