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Article Summary: "Interest rates on a loan can have a devastating effect all one has to do is look at the current mortgage crisis. With the increase of an interest rate the premiums that people must pay on their loans rise and sometimes they rise far above what they are able to afford. This can lead to an inability to pay and that leads to a foreclosure."

Home > Math Tips > How a single percentage point (+ or -) in an interest rate can change your life?

How a single percentage point (+ or -) in an interest rate can change your life?

When people apply for a loan or a credit card they look for the lowest interest rate available. Similarly, when someone looks to invest money the goal is to find an investment that pays the highest rate of interest. After all, would you rather pay back a loan that has a 14% interest rate or would you rather pay back a loan that has a 20% interest rate? Or, would you rather invest in a mutual fund that pays a 5% interest rate or one that pays a 9% interest rate? Such choices are obvious because of the significant monetary differences. But what about choosing between a loan or an investment that offers a 8% rate of interest or one that offers 9%? Clearly 1% couldn't possibly mean that much especially when some loans and investments that come with a number of perks that make you look past the interest rates. But should they? A point of interest is a lot more than what it may initially seem. For example, if you asked a loan officer to reduce the rate of interest 1% you would probably find a great deal of resistance. The reason for this is that 1% most definitely means a lot particularly when compounded interest over time is factored. The same would go the in compounded interest on an investment as well.

 

Let's look at the interest on a deposit in an investment that pays 10% interest compounded annually. Say you invested $1,000 dollars and left it in the account untouched for five years. The interest would bring you 1,610.51. If that interest rate were changed to 11% it would yield 1,685.51 which is an increase of $75.00. Now, some may say that $75.00 is not very much but this would be a very shortsighted opinion. Look at it this way, if you went in a store and wanted to purchase a $50 item and only had $40 they simply are not going to give you the $50 item at a discount. That is just not the way life works! Every dollar you earn or save counts because if you have access to even minute amounts of cash you can make that capital work for you. Just look at the life of Daniel K. Ludwig.

When Ludwig was very young he took $25 and bought a salvaged boat which he used to start a shipping business. His shipping business grew and grew and his $25 investment ended up being worth several billions of dollars. Clearly, a billion dollars can change a person's life! But without that extra $25 Ludwig would never become such a success. Similarly, the increase of decrease of a single percentage rate can either create or deny the next generation of Daniel K. Ludwig's in the world.

While not everyone can be a billionaire shipping entrepreneur most can own their own home by taking out a mortgage. But, if you have a mortgage that has a high percentage rate then you may find yourself in trouble. Let's say you took out a $200,000 30 year fixed mortgage interest rate (that means unlike a variable interest rate it will not change) and during the course of those 30 years you will pay a little over $259,000. If you maintain the exact same loan but if you raise the interest rate to 6.5% then the amount you will end up paying will be roughly $308, 600. Now, if an extra $75 can change your life imagine what an extra what an extra $49,600 would do! This is to say nothing of the fact that you now have the burden of having to pay an extra $49,600.

Similarly, if you truly want to see how the increase of the percentages of an interest rate of a loan can have a devastating effect all one has to do is look at the current mortgage crisis. With the increase of an interest rate the premiums that people must pay on their loans rise and sometimes they rise far above what they are able to afford. This can lead to an inability to pay and that leads to a foreclosure. A foreclosure refers to the bank that holds the loan seizing the property in light of defaulted payments. Now, if losing your home and all the monetary investment you have put into isn't life changing then nothing else is!