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
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