Last week I talked about “How we learn to accept debt.” If you missed that post, you can review it HERE. This week’s post is “What is interest?” We are taught that interest is just an additional cost of doing business or the fee that we pay to finance something. But what is it really? Learn more in this week’s blog.
Paying interest is something people accept without thinking much about it. We are trained from an early age to accept debt and the interest that you pay as a “necessary” expense. But when you come right down to it, what is interest?
The Merriam-Webster dictionary defines interest as “a charge for borrowed money, generally a percentage of the amount borrowed”. It is something you pay to the person that is loaning you the money. But that definition doesn’t fully explain what interest is. It only describes it in a way that hides the true effect of borrowing: paying more for your purchase.
The training that we get when we are learning about debt gives you the impression that going into debt and paying interest is normal, something that you will definitely do and have to pay. That is great if you are the one collecting the interest, but not if you are the one that has to pay it.
Interest really is a price increase on what you are buying. Even if you get a “discount” on the item, by the time you have finished making your payments, you generally have paid more for the item than you would have by paying cash. Even zero interest loans cost you more. The seller has inflated the price to make up for the interest they are not going to make. You often find this kind of financing at car dealerships where the financing company is a different division of the same company. The salesman often sells you a more expensive model because you are “saving so much money on interest”.
Think of what you pay when you finance a house. By the time you are finished making your payments, especially on 30 year loans, you often have paid double the “purchase price” of the home. All that interest is described as the financing fee, but it is really additional money that you have to pay for your purchase. Is your house really worth double the asking price?
When people are getting loans, but only looking at the payment amount, they don’t consider how much more interest they are paying to get that lower payment. The only way to lower the payment without changing the interest rate (which you know the finance company is not going to do) is to make more payments on the loan. This means the finance company will stretch out the loan to make it last longer. Then you pay interest on the loan for a longer period of time. You pay even more for the product and are in debt longer. This can easily add 10% or more to the interest you are paying.
When you are carrying a balance on a credit card, you are increasing the cost of everything that you buy with the card. The interest rate is usually higher than with most loans, because it is an “unsecured” loan. That means that they don’t get the title to something that you own. They have nothing that they can take away from you if you quit making your payments. In addition to making everything you buy more expensive, it also means that you will not be able to buy as much as you could have if you saved your money and paid cash instead. As a result, you pay more for what you are buying and you have less money to use to make purchases.
So from the buyers perspective, paying interest makes you pay more for what you are buying and limits you to buying fewer items.
Keep that in mind the next time you are ready to use your credit card or sign your loan papers.
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God Bless your week!