...or how to easily double your debt
The Rule of 72
by Patricia Mayo
What You Need to Know Before You Shop for an Auto Loan
The 10 Things You Need to Know about Compound Interest
Compound Interest for Poor People
Who wants to buy one car for the price of two? All you have to do is get a loan for six years at a 12% interest rate, and pay it off as scheduled. Gross, isn't it?
Actually it's compound interest. It's bullish if you're getting it, but a real beast if you're the one paying it. Most people know about the magic of compounding investments, but it works the other way too. And just as some rates are better for investments than others, debts should also be avoided with certain interest rates, unless you enjoy doubling your debt.
Time isn't the only factor, but it's the biggest. The Rule of 72 is Einstein's simple shortcut to figure out how long it takes for an interest-compounded value to double. It's not exact, but it's never more than half a year off. Just divide 72 by your interest rate, and there you have how long it would take for the loan or investment amount to double.
So 1% would take 72 years to double. 5% takes about 15 years to double. 10% takes 7.2 years to double. 20% takes 3.6 years to double, and 36% doubles in just two years. So if your loan duration is long, as in home loans, keep in mind it takes even less time for it to re-double (or quadruple). And it's usually redoubling about half a year quicker for most good-credit rates.
As in the example above, if you're buying a car with a loan (which is typically never more than six years), you want to stay under 12% interest to avoid paying double. And 12% is a magic number too, being the first to quadruple in almost two years less time than it took to originally double. Therefore, as soon as your interest rate is 12% or higher, your debt is growing at the fastest rate possible.
Bad credit isn't entirely hopeless though. If you find yourself stuck in a position where you cannot get a good rate, you should then shop around for a loan that welcomes early payment. It's more than avoiding early-payment penalties though. The loan should also get recalculated every time you make a payment on the date you made the payment regardless of due dates.
In other words, you can avoid doubling your debt if you can pay more often. Obviously paying more than your obligation helps too, but you can effectively cut up to 10 points off your rate just by dividing your monthly obligation into at least bi-weekly, if not weekly, payments. So if you have a $400 monthly obligation, paying $100 every week cuts back on the interest accrual, saving thousands over the course of the loan.
Want to pay off your car faster? Consider refinancing into a lower auto rate.
However, that only works if your loan doesn't have a static monthly payment term. Talk to the underwriter or loan advisor about the terms of your loan. They will be able to tell you whether it is amortized on payment or on a specific date regardless of when you paid.
By the way, if you can't get a used car loan under 12%, you should buy new. Legally, new car loans can't exceed 8%, and you can still get an early-payment loan on that too.
Take the Next Step:
- Find out if you are heading for debt trouble. This simple checklist can help you determine if you are and point you in a better financial direction.
- Get the interest you deserve! Compare money market and savings account rates with our best rate finder. It only takes a minute and your privacy is completely protected.
- Looking for a new credit card? Check out which is the best card for you. You can compare them here.
- Stop struggling to get ahead financially. Subscribe to our free weekly Surviving Tough Times newsletter aimed at helping you 'live better...for less'. Each issue features great ways to help you stretch your dollars and make the most of your resources. Subscribers get a copy of Are You Heading for Debt Trouble? A Simple Checklist And What You Can Do About It for FREE!
Share your thoughts about this article with the editor.