L40) Infinite Banking Borrowers View vs Bankers View of a Loan. Interest Rate Calculation versus Interest Volume Calculation.

How can an 8% interest charge rate end up equaling 21.66% interest paid, over 5 years?

Mathematical Math vs Money Math

Below is a borrowers view of an amortized loan.

What borrowers are taught to care about is the interest rate, which in this example is 8%, and the monthly repayment which in this example is $405.53. The term for this loan is 5 years or 60 repayments.

The questions we ask ourselves are, “can we afford that monthly repayment amount and how low can we get our percentage charged rate to be?”

 

Let’s take a closer look at this loan.
If we look at the far right very bottom number, we see that the ‘total payment % of loan‘ is $121.66%. That means we have actually paid 21.66% more than the original $20,000. That equates to paying an overall interest volume equaling 21.66%, NOT 8%.
Now, let’s look below at this exact same loan from the point of view of the Banker for a moment. Let’s look at how we ended up paying an actual VOLUME of interest of 21.66%, or the actual number of dollars, which is what the bankers are really caring about.
Notice under the column titled “Interest Volume – Total interest % of payment” (the first yellow column), NOT for even  ONE YEAR does the interest portion of the monthly payment over the entire 60 months read 8%. How can that be? See below to find out where the 8% fits in to each loans calculations.
So where does the 8% fit into all these numbers?
How is a bank allowed to advertise and tell you you are only paying 8% when in fact you are paying over 21% over a 5 year period of time?
There is a big difference between Mathematical math and Money math. The 8% is the mathematical math and the 21.66% is the actual money math.
Let’s see how they figure all this out.
Monthly payments =$405.53
MONTH ONE
Step 1: Divide the annual interest rate (8%) by number of payments per year (12). 8/12 = .66667%
Step 2: Multiply the principal owing each month (which will lower each month) by the monthly rate .6666%.
Month one – $20,000 x .0066667 = $133.33 interest part. Principle = $272.20 part of payment.
Step 3: Subtract principal part ($272.20) from principal balance.  $20,000 – $272.20 = 19,727.80 to arrive at month 2 principal total owing.
Step 4:  Understand that $133.33 / $405.53 = 0.32877 x 100 = 32.88% of total month 1 repayment is interest volume being paid.
MONTH TWO
Step 1: $19,727.80 x .0066667 = 131.52 (interest portion of payment). $405.53 (Monthly payment) – $131.52 (Interest payment) = $274.01 (Principal portion of month 2 repayment)
Step 2: $19,727.80 (month 1 principal owing) – 274.01 = $19,453.79 (principle owing after month 2 repayment)
Repeat process 58 more times.
Question?
Have you taken a car back to the dealer because they offered you a new car before the old car was fully paid off telling you they would just roll what’s left on the loan into the new loan? And you, thinking there couldn’t be much left of what I owe so that sounds like a good deal and so have accepted that offer. And maybe they even entice you to do that with a lower interest rate or maybe even a zero interest rate?
Well, if we look at the far right column coloured in yellow with the title “Interest Volume – yearly interest % of payment” we see that the last 12 months of payments the % of payment that is interest gets down to as low as 4.2%. Banks or financing companies don’t like that low a gain and they want to roll over the last years money into a new loan so you will begin paying them over 30% again.
Notice you still owe, before repayment at month 48, $5,033.72. That is more than 1/4 of the principal even though you have been paying the loan for 4 years already. So that $20,000 (original principal) – $14,966.28 (paid back after 4 years) = $5,033.72 still owing. It is this amount that will now be rolled over into the new loan where you begin to pay the over 30% interest volume again, in this example.
Car loans eat so much of our wealth, and it is not just the number of dollars of interest that is lost it is the lost opportunity of those dollars for the rest of our lifetime that is also lost.
What does that mean?
If JUST the INTEREST is taken into consideration, that $4,331.80 that was handed over to the bank, if it was invested at say 4% over your lifetime, but let’s say 40 years now has a lost opportunity cost of $20,797.06 – $4331.80 = $16,465.26, depending on where you housed your money to have it grow.
If your $4,331.80 was housed somewhere earning a simple interest calculation then below is a different conclusion; but it is still an increase in your wealth.
You want to calculate the interest on $4331.80 at 4% interest per year after 40 years.

The formula we’ll use for this is the simple interest formula, or:

Where:

  • P is the principal amount, $4331.80.
  • r is the interest rate, 4% per year, or in decimal form, 4/100=0.04.
  • t is the time involved, 40….year(s) time periods.
  • So, t is 40….year time periods.

To find the simple interest, we multiply 4331.8 × 0.04 × 40 to get that:

 

The interest is: $6930.88

 

Usually now, the interest is added onto the principal to figure some new amount after 40 year(s),
or 4331.80 + 6930.88 = 11262.68. For example:

  • If you borrowed the $4331.80, you would now owe $11262.68
  • If you loaned someone $4331.80, you would now be due $11262.68
  • If owned something, like a $4331.80 bond, it would be worth $11262.68 now.
THINK ABOUT THIS NOW: Didn’t you also hand over all that $20,000 of principal to the bank as well? What is the lost opportunity of that money? There is a more lucrative way of handling your financing needs. Call me for a webinar appointment NOW! Jennifer 845 649 7487
Share

July 8, 2013 · Jennifer · No Comments
Tags:  · Posted in: Uncategorized

Leave a Reply