Posted by admin on July 20th, 2009 | Comments Off
For every month that goes by, 1% of the balance (12% divided by 12 months) is going to get added to the balance. The following month, that 1% is calculated on the new balance. For example, after one month, the balance would grow to $1,010. That’s $1,000 times 1%.
After another month, with no payments, the balance would grow to $1,020.10. The balance grew not by $10 like the month before, but $10.10. The difference comes from the fact that interest was calculated on the new balance, not the original. It doesn’t take long before this interest-on-interest growth of the balance mushrooms beyond control.
It’s not hard to see that with higher-interest-rate loans, this can spiral out of control. This is especially true when you are making the minimum payments, getting late fees added to your payments, or even skipping payments altogether. To add insult to injury, many companies begin raising their already-high interest rates when you don’t keep your account in good standing.
To make matters worse, most interest is compounded daily, not monthly. This only speeds up the effects of compound interest, and leaves you making much slower progress than you need.
Posted by admin on July 6th, 2009 | Comments Off
Albert Einstein, perhaps the most brilliant mind of the twentieth century, had an opinion about compound interest. He’s quoted as saying, “Compound interest is the most powerful force in our universe!”
Now, I know our old friend Albert was being a little sarcastic, but he’s got a semivalid point. Compound interest is a force to be reckoned with. For those who are owed compound interest, it can make them wealthy. For those who owe it to someone else, it can be an anchor around your financial neck.
Guess who loves to charge compound interest? You got it … credit card companies, payday loan providers, and other types of questionable lenders. It’s part of the reason that paying off credit cards is a far greater struggle than paying off a car loan—even when they’re at the same interest rate.
The magic of compound interest is that you are charged interest on your interest until the loan is paid off. In other words, a little bit of interest is added to your debt every month, week, day, or even every second. Then, in turn, you are charged interest on that new slightly higher balance, during the next period.
Like a car that’s lost its brakes on a steep and winding road, it doesn’t take long to go over the edge! Let’s look at an example of a 12% credit card, with a $1,000 balance, that compounds its interest every month.