There are two kinds of people. There are people who pay interest. And there are people who collect it. A daily barrage of advertising works to convince those who pay interest that it is a good idea.
It isn’t.
The “interest content” of our lives is constantly rising. Year after year the consumption of goods and services is being displaced by interest payments on mortgages, loans, and credit cards.
Does the phrase, “interest content”, throw you a little? Well, think of it as a little figure at the side of every purchase document. It shows how your choice of payment plan will affect how much interest you’ll have paid when you’ve completed the transaction.
Just as there’s a little sticker on every refrigerator, stove, or automobile indicating how many kilowatts or gallons it will consume each year, the “interest content” sticker would show how much of your purchase commitment was going to pay the lender.
Let’s take a look at some examples:
- A Typical Home Mortgage. Somewhere in the truck load of documents you sign when you buy and finance a house there is a statement about your mortgage. It shows how much you have borrowed, your interest rate, and the total cost of your loan until it is paid off. The numbers are intimidating. If you borrow $100,000 at 7.5 percent for 30 years, for instance, your monthly loan payment will be $699.21. That means you’ll pay a total of $251,717.22, of which $151,717.22 will be interest. The “Interest Content” sticker for this loan would read 152 percent. Make one extra payment a year and the maturity of the loan will drop to about 23 years and the interest content will plummet.
- Home Equity Loans. Nationwide, many of these loans are offered on the “never, never” plan— borrow now and pay interest only. The loan is repaid when the house is sold, say 10 years later. At a fairly typical 8.5 percent rate, the “interest content” sticker on such a loan would read 85 percent.
- Buying A Car. The Interest Content of a car purchase depends entirely on how long it is financed. Buy it for cash and the interest content sticker would read “0 percent”. Finance it for a year at typical rates and the interest content will be about 5 percent. It rises for each additional year: 10 percent for 2 years; 15 percent for 3 years, 20 percent for 4 years; and nearly 25 percent for 5 years. The longer the financing period, the higher the interest content. Result: more interest, less car.
- Leasing A Car. A car lease, advertisements regularly tell us, is for people who only want to pay for the amount of car they actually use. In fact, a lease is just another way to raise the interest content of the transaction. Examining a recent 3 year lease, for instance, I found the interest content was 56 percent. A commitment to leasing instead of ownership may reduce your monthly payment… but it will more than double the interest content over a long term loan.
- Credit Card Balances. Debt reduction guru Marc Eisenson likes to give the example of how much it costs to use a credit card to pay for restaurant meals you can’t afford. If you had $1,000 of credit card meals and then paid for them on the slowly declining schedule provided by a typical credit card you’d eventually pay some $2,590 to your lender. One thousand dollars would be for the meals, $1,590 would be for interest. Interest Content: 159 percent. “It gets to be very expensive pizza”, he says.
You don’t have to examine this list too closely to be very aware that the history of the last 40 years has been a constantly rising “interest content” in the consumer budget.
Query: What is the “interest content” of your life? For a household that is financed according to typical lender guidelines, it could be nearly 25 percent of gross income. More typically, it would be about 20 percent. Either way, interest payments are the single largest item in most household budgets today, dwarfing payments for federal income and employment taxes.
What does this mean?
Peril… and opportunity. It means peril in the next recession as families find they are overextended and can’t repay the funds so generously extended.
But it also means opportunity, today, for any person or family that decides to reduce the “interest content” of their life. With as much as 25 or 30 percent of gross income at stake, becoming debt free would bring a major increase in spending or saving power to those who understand that it is more fun to receive interest than to pay it.
This information is distributed for education purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service.
Photo by Andrea Piacquadio
(c) A.M. Universal, 1997