On today’s show, we talk about paying compound interest. We’ll discuss:
- The impact of time
- The impact of the interest rate
Be sure to scroll down for the charts and graphs that help illustrate how this can impact you.
Watch: Paying Compound Interest
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Free Download: The Impact of Paying Compound Interest
Compound interest is a tricky subject. So we created this free download to help illustrate how it can impact your life. To download your free copy, please click on the button.
Paying Compound Interest Example 1: The Mortgage
How does compound interest make you pay? The best example is the mortgage. Most of us borrow money to buy a house. And one of the common decisions is choosing between a 15 or 30-year loan. So let’s look at how this plays out.
30 Year Mortgage
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You borrow $100,000. Right now, rates for a 30-year mortgage are about 4%. This means your monthly payment is about $478. Because of the effects of compounding, the total cost of this loan over three decades will be $71,870.
15 Year Mortgage
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If you borrow the same amount over 15 years, your interest rate is lower—about 3.38%. But your payment is also higher. It jumps to $709, not quite twice as much. But over 15 years, your total interest cost is $27,576.
A 15-year mortgage, if you can afford the payment, will save you over $44,000 in total interest expense. That’s nearly half of the loan amount.
For most people, a lot goes into their decision about whether to do a 15-year or a 30-year loan. And the primary factor is the size of the payment. But this illustrates how powerful time can be.
Paying Compound Interest Example 2: Credit Cards
Let’s look at another common example. Credit Cards. Many credit cards require you to pay 2% of your balance as a minimum payment. And credit cards often have rates which could exceed 20%, but let’s use 20% for this example.
Credit Card Repayment
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You start with a balance of $5,000 and make no other purchases. Your minimum payment is $100. You pay this each month until you eliminate the debt.
It will take you 9 years, and it will cost you over $5,800 in interest. This means you pay more in interest than your original purchases.
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About the Author
Neal Watson is a Certified Financial Planner™ Professional and a Financial Advisor with Fleming Watson Financial Advisors He typically works with people who are planning for retirement. Fleming Watson is a Registered Investment Advisory firm located in Marietta Ohio. Our firm primarily serves Marietta, Parkersburg, Williamstown, St. Marys, Belpre, Vienna and the surrounding communities in Washington and Noble Counties in Ohio and Wood and Pleasants county in West Virginia.