Summary: Did you know your minimum credit card payment is rising? A new government program working to get Americans out of credit card debt is pushing credit card issuers to raise minimum monthly payments. Will you be able to make the higher monthly payment? Here are some tips for getting by.
If you’re an American, your minimum monthly credit card payment may soon be doubling. If you’re only paying the minimums now, you’ll have to be careful to adjust your budgeting to pay more.
Who’s Raising Your Monthly Minimum Credit Card Payment?
Whose idea was it to increase credit card minimum monthly payments? The Office of the Comptroller of the Currency, a bureau of the U.S. Treasury Department that has become more and more involved with reigning in the abuses of credit card companies. Yes, this credit card minimum payment increase was thought up by people trying to help you.
Who will be raising their monthly minimums? So far, some of the largest credit card issuers have agreed to the new standards. Bank of America has already been asking for the higher monthly minimum payment. MBNA, Citigroup (a.k.a. Citbank), Discover, and Chase (on some of its cards) will be breaking the news to their cardholders as Fall 2005 progresses.
How Much Will Credit Card Minimums Increase?
For many credit cards, such as MBNA and Bank of America, the new rates mean that monthly minimum payments will double.
Right now, the monthly minimum payment is only 2% of the balance on most of these cards. The new rate will be around 4% (the actual number may vary from card issuer to card issuer). This means that if you have the average American credit card balance of about $10,000, your minimum monthly payment will go from $200/month to $400/month.
Of course, if you have any additional fees, whether a late fee or a cash advance fee or any of the other fees that the credit card guys cook up, you will have to pay that, too.
Why the Credit Card Minimum Payment Increase?
You may be wondering why anyone would want to make you pay a higher minimum monthly payment. The basic reason for making you pay more is: for your own good.
According to Mike Peterson, co-founder of American Credit Foundation, by doubling the amount you pay per month toward credit card debt, you will cut down on what you pay toward interest by much more. Look:
Old monthly minimum payment of 2% of balance, $2,000 credit card debt at 18% percent interest:
* Time to pay off debt in full: about 30 years.
* Interest paid: about $5,000two and a half times what you initially borrowed!
New monthly minimum payment of 4% of balance, same debt:
* Time to pay off debt in full: about 10 years. Time saved vs. old payment: 20 years.
* Interest paid: about $1,100slightly more than half what you originally borrowed. Amount saved vs. old payment: $3,900.
Tips for Paying Double Easily
How do you pay off your new, higher credit card balance?
Stop Charging
Yes, you will have to make major sacrifices to stop using your credit card. But just look at all the money you’ll have in ten or thirty years that you wouldn’t have if you had to pay all that credit card interest. If you have trouble resisting the temptation to charge, here are some solutions that have actually worked:
* Give your credit cards to a friend or family member to hold in safe keeping.
* Freeze the cards in a block of ice.
* Never carry more than one credit card with you.
Economize on the Small Things
According to Michael Peterson of the American Credit Foundation, even tiny savings really add up when it comes to debt. His favorite example is the Diet Coke example:
* If you buy one Diet Coke a day at $1/day, that’s $365/year.
* If you instead invested that one dollar a day at 10% interest (the average yearly return on major stocks over the last half century), you would be a millionaire within 56 years.
* Of course, with credit cards, this logic works in reverse: if you are lucky enough to be paying only 10% interest, fifty years of charging Diet Coke to your credit card will mean you’ve lost the same amount, not only in interest paid, but in the lost opportunity to save and invest.
* You don’t have to put aside one dollar a day for fifty years to see a big difference. One dollar a day is $30/month, 15% of the average $200 increase in credit card minimum monthly payments.
* In order to get that entire $200 increase out of your daily budget, you would only have to save $200/30 or less than $7 a day. OK, maybe you aren’t drinking seven Diet Cokes a day. But there are very few credit-card-holding Americans who can’t cut $7 a day out of their spending.
* Saving weekly rather than daily, $200/month works out to about $45/week, or the cost of a restaurant meal for a small family–another luxury you might want to skip until you’re debt-free.
Bigger Savings
* Taxes. Most Americans could pay hundreds of dollars less tax each year if they just took all the deductions they were eligible for upfront, rather than waiting to get a refund in April. By April, you will have spent a big chunk of money on interest on debt that you wouldn’t have spent if you’d had the money at hand.
* Pleading. Call the credit card companies and ask if they can allow you to set up a payment plan, or at least provide a brief extension. Simply calling and letting them know you haven’t forgotten about them can help keep you out of the worst trouble.
* Credit counseling. Credit counselors can talk with credit card issuers to help you get a repayment plan you can keep up with. They can also open your eyes to untapped sources of income you never knew you had, like kicking the $1,000,000 Diet Coke habit.
In short, don’t panic. With only a little bit of planning, you can make the higher minimum monthly payment work to your advantage, just as the policy’s authors intended.
Even though rates are on the rise, that doesn’t mean you shouldn’t refinance.
Practically everyone has refinanced or thought about it at one point in time. We’ve seen the dozens of commercials that urge us to do it. With rates at record lows over the past few years, refinancing has helped many borrowers lower their monthly payments.
But rates are now on the rise. Refinancing applications have fallen slightly. Most people don’t think you should refinance when rates are going up. However, many refinancings are “cash-out” refinancing. That means that equity is handed over to the homeowner in return for a larger mortgage. Many people need that cash.
Some people are refinancing their homes for a “cash-out” because they have a significant home-equity line of credit balance. This line of credit has an adjustable-interest rate, which is going up on them. They refinance it in with their first mortgage at a fixed rate. They aren’t eliminating the debt, just fixing the interest rate and monthly payment. If you don’t need the revolving line of credit, you should probably take advantage of the fixed rate.
There are many homeowners that piggyback their mortgages when they are buying. They end up with one mortgage for 80% of the value of the home and a second mortgage for 10%. They put the remaining 10% down on the home. Since the first mortgage is only for 80% of the purchase price, they avoid having to pay PMI.
Many piggybackers have a line of credit as the second loan. Others simply want to consolidate into one loan that would be easier to keep track of. Either way, refinancing into a fixed-rate isn’t a bad idea. And one payment is easier to make on time each month than two.
Those out there with adjustable-rate mortgages are starting to get a little nervous. Interest rates have been rising pretty fast. The gap between the rate of a adjustable mortgage and a fixed mortgage has narrowed so much that you really don’t save much by taking the adjustable mortgage. Many are looking to avoid rising interest rates by financing to fixed-rate mortgages.
Refinancing can be a good thing. You can get a fixed rate to counter the rising interest rates. You can use cash from a refinancing to consolidate your debt. You can improve your home. But you should be careful about taking too much equity out of your home.
Many advisors warn consumers not to use their homes as personal piggy banks. If home prices decline, you could owe more than your house would sell for. In a cooling, or slowing, real estate market, you do not want to be maxed out on the equity in your home. If something happened and you had to sell, you want to walk away from the closing table with money, not have to go to it with a check. Paying to sell your home isn’t how you want to do it.
Fixed-rate mortgages are always a good and solid financial choice. Anytime you are looking to refinance, your best option is to go with the shortest-term, fixed-rate mortgage you can afford.
Working Capital & Cash Flow Solutions: Should I Borrow From A Bank?
Recently, my newspaper reported that a local bank …earned a four star excellence rating for the sixty-fourth consecutive quarter. Thats sixteen years of four star excellence! The article went on to say that the rating is based on a complex formula that includes capital safety levels, quality of loan portfolio, and the ability to meet obligations The press release was designed to showcase the value of this bank and demonstrate its prominent position in the economy.
As a former banker with over seventeen years of commercial experience, I chuckle at this information being tossed around by the bank and its regulatory agencies for self promotion and marketing purposes. I suppose that if you are a blue-hair whose purpose is to find somewhere other than under the mattress to keep your retirement funds, this article was good news. But what does it mean to the business owner or entrepreneur looking for a Funding partner to participate in an opportunity to grow, increase jobs and profit? In a nutshell this type of information should be a wake up call to find another bank-heres why.
Lets explore the underlying meaning to business customers behind a portion of this complex formula.
Capital Safety Level
In laymans terms this means that the bank has more than adequate reserves of Cash. Cash that is available, but not loaned out its Capital Safe. Banks that have high reserves of Capital can be presumed to be low on the scale of aggressive lending. They hoard Cash – even though they cannot make the same return on reserved Cash as they can on employed Cash. But for the bank, its less risky to hoard Cash than to loan Cash, and therefore contributes to their four-star excellence rating.
Quality of Loan Portfolio
A high quality loan portfolio means that the banks loan loss experience is at or above levels set by regulatory agencies. One can infer that the bank therefore takes fewer risks. Bankers are not supposed to be entrepreneurial or take risk. A banker has never been rewarded for taking risk! The banking system rewards those who can decline any borrowing request outside of the underwriting parameters. Loan portfolio quality thats high = low loan accessibility to business owners. It stands to reason that banks are not risk takers based upon the low returns they are willing to accept.
Banks with four star excellence ratings seek out commercial customers who are stable and have limited need to borrow. The other 72% of business customers are left outside the circle of these banks. Where do these businesses turn to Cash Flow the Working Capital needs of their business? Where do they go to fund opportunities for growth and development of new market niches? More often than not they turn to the widely accepted world of non-traditional funding sources – preferred SBA lending companies for real estate and fixed asset needs, leasing companies for equipment needs, and Factoring companies for Working Capital needs. These non-traditional funding sources evaluate opportunities to participate by lending funds to small & medium sized businesses. Non-traditional lenders rates on borrowed funds may be higher than traditional bank rates, but their mission is to employ funds to obtain a return, not to let cash sit idle on the sideline in order to obtain a four star excellence rating. Their pricing reflects the perceived risk. And, they are not restricted by regulatory bureaucracy or fear of losing their four star rating as banks are.
In this ever changing world, business owners are advised to explore opportunities outside of the traditional financing channels. Before a need arises a business should be familiar with alternative funding sources. And perhaps, when your bank informs you that they continue to achieve a four-star excellence ratingit would be wise to investigate your options pertaining to Working Capital and Cash Flow solutions.
Will Chinas New Five-Year Plan Force U.S. Utilities to Ration Your Electricity?
According to Chinas Ministry of Land Resources, China plans to build up sufficient reserves of uranium and other minerals, in a new five-year government plan. The ministry said it would be stockpiling strategic reserves of uranium, copper, aluminum and other key minerals because of rising demand for those commodities. The Chinese also wish to avoid supply disruptions by hoarding uranium and other minerals, over the next few years.
Until now, youve probably taken for granted a steady, reliable source of electricity. A large part of your dependable energy came about because of the nuclear energy generated by the 103 nuclear reactors in 30 states. Without a steady supply of uranium to power those nuclear reactors, the U.S. electrical transmission network suffers a 20 percent loss. Chinas new five-year plan to stockpile uranium had better be a Wake-Up Call to U.S. utilities. If they missed the import of Chinas announcement, we are all going to be in a heck of lot of trouble before this decade ends.
Since June 2004, we have warned of supply disruptions for uranium. David Miller, who has since become President and Chief Operating Officer of Strathmore Minerals, argued at the time, In my opinion, no one has any extra uranium to sell on the spot market. Theres just not excess inventory that people are unloading in the spot market. We interviewed Miller again in November 2005, for an article entitled, China Demand for Uranium, World Growth in Electricity Demand to Drive Uranium Price Higher. Miller warned us, China is the future wild card what they are planning for nuclear is probably the most aggressive program in the world. Miller added in his explanation, All the new production is already factored into the future market for uranium. Were underwater right now without building one more nuclear power plant.
In mid April, during an interview with Sprott Asset Management Market Strategist Kevin Bambrough, we asked him about the Chinese. He answered, Why shouldnt they have strategic uranium reserves to supply their nuclear reactors? It makes sense to have a good stockpile of uranium considering the relative cost of nuclear power versus anything else. And now, the Chinese plan to build up a strategic reserve of uranium for their aggressive nuclear program.
In another interview, also published in April, Gene Clark, CEO of TradeTech LLC warned us, In reality, the U.S. utilities, which tend to wait longer to contract, may be the ones on the losing end because the Chinese and the Indians will contract early. The implication of current group-think is that the Chinese and Indians are not going to be able to find enough uranium for their new plants. But, they are committing for supplies way out into the future. When the U.S. utilities come to the market, theyre going to look around say, Oh blankety- blank, what happened? Wheres the uranium? Theyll be the ones that sat around. I think that is whats going to happen unless things really change in the way contracting is done in the United States.
U.S. utilities have been cautioned, warned and advised that the Chinese demand for uranium could very well create a serious energy crisis for the U.S. grid. Nuclear reactors help supply the baseload generation for the U.S. electrical grid. Nuclear power plants provide stability to the electricity transmission network. About one-fifth of electrical generation is derived from nuclear power. Nuclear plants are running at more than 89 percent capacity. U.S. utilities are fiddling around like Nero, who watched Rome burn, hoping that promises of increased uranium production will stem the dramatic uranium price rise.
Severe strains in natural gas supplies, combined with the ongoing uranium supply squeeze, could very well put U.S. consumers on rations for their electricity. Cant happen, you say? Ask the Brits about how business was conducted in their country, in late 1973 and early 1974, during the Arab oil embargo crisis. Or more recently, Californias rolling brownouts.
An electrical energy crisis is in the making, while U.S. utilities are patiently hoping or praying the price of uranium stop climbing. UxC President Jeff Combs wasnt kidding when he urged U.S. utilities, during our interview, to support the expansion of (uranium) production in the United States. And if you dont let your local utility know about the upcoming electrical energy crisis, then perhaps it will be your lights they may someday be turning out. The irony of ironies: All of those sweet anti-nuclear folks in Vermont, who depend upon nuclear energy for more than 70 percent of their electricity? Theyll be the first to suffer the most, if U.S. utilities dont respond to Chinas five-year plan.
If debt is currently an issue in your life, debt consolidation really can save you from the stress of bills, debt collectors, and the nagging thoughts of foreclosure or even bankruptcy. Debt consolidation can drastically change your life within weeks, months, or years depending on your current debt situation. Consolidating your debts will allow you to live with peace of mind that you are taking care of your financial obligations while continuing to live a happy life.
Debt consolidation is taking all of your bills and fitting them into one monthly payment. Fitting all your bills into one payment also means one interest rate, which will limit the amount you pay out every month, saving you a lot of money in the long run. Debt consolidation also makes paying off multiple debts easier because the monthly payments can be lowered when you take away insane interest rates. The average debtor pays more interest every month than they do on the actual principal balance of their debt! Eliminating the sky-high interest rates is a good start to getting your debts paid, without going completely broke.
Many people assume when they cant pay the bills its time to just throw up their hands and consider drastic actions such as foreclosure, repossession and bankruptcy. While there are some extreme cases where bankruptcy would be the best option, foreclosure is almost always avoidable as is repossession. Banks, car dealerships, mortgage companies, and creditors dont like to have to take back property or write off your debts, they would rather work with you on debt consolidation so that they can get back what they are owed and you can go on your way with your credit still in tact. Bankruptcy, repossession, and foreclosure are not easy outs when it comes to debts; in fact, they are choices that will continue to affect you for a long, long time. Consider debt consolidation before making any hasty decisions.
Debt consolidation on your own can be tricky, or downright impossible depending on your credit situation. Luckily, there are debt consolidation companies waiting to help people who are in over their head, just like you! Debt consolidation companies will take your credit report and any unreported debts that you can give them and work out a payment plan for you. These debt consolidation companies often contact each company and strike a deal to lower or get rid of the interest and even split the balance of the amount due. Obviously, lowering or getting rid of interest and part of each debt will limit what you spend each month, enabling you to actually pay the bill.
Whats the catch with this type of debt consolidation? Well, there really isnt one. Yes, this is a business and the consolidator does make money because while he takes away the interest that each company is charging, he will charge you interest or a percentage of what you owe. Doesnt seem fair? It is! It works out better for you, because even though you are still paying interest its just one interest payment for all the debts you currently hold. So, instead of paying twenty seven percent to ten companies youll pay twenty percent to one company. So, you go from having multiple payments and interest rates to just one payment for all the bills and one interest rate. It works! If you follow the plan, and make your monthly payments debt consolidation will soon have your credit report looking much better than it does right now.
You may think that you have so much debt you cannot possibly afford to repay even on a debt consolidation plan. Youd be surprised what these companies can get done on your behalf. And, if your debt is that outstanding you can work through the process slowly, a few debts at a time. There is nothing wrong with the process taking a while, as long as you keep up with the process and intend to actually pay off your debts. Getting your credit where it should be does take time, but its worth it. Your credit is your buying power, and each payment you make gets you closer to having more of it.
Worried that the companies you are dealing with wont work with a debt consolidation company? Youd be surprised. Yes, the companies will loose a little bit of money compared to if you showed up with cash to repay the debt tomorrow, but in the long run its better for them to take a debt consolidation deal than not. Most companies figure theyd rather get a portion of your debt back and settle the deal than not get anything back at all. Getting seventy five percent of your debt back is more reasonable to them than to keep paying debt collectors to contact you and try to get the money back. All in all, any money is worth striking a deal over, and that is why a debt consolidation company can really get you where you need to be. They are professionals and they know how to get companies to agree to their terms.
Debt consolidation companies will usually work with you to get your debts paid off within a reasonable monthly payment. Each month youll make just one payment, reducing the time and stress of paying the bill, and each month youll be a step closer to financial freedom. Paying off your debts, through debt consolidation or otherwise will take a weight off your back that you may not even realize is there. No one wants to have unpaid debts, but sometimes life gets in the way and it happens. It happens to the best of us. But, dont be too proud to consolidate those debts and get back on the right track. Open up your local phone book, or get online and find a debt consolidation service in your area. Contact a debt consolidator not with shame, but with pride, because you are stepping up to do the right thing.
The small business credit card market is a rapidly growing market in the financial services industry. If you are planning to apply for small business credit cards, see how your reasons compare with those of other business credit card holders:
Business credit cards provide credibility and legitimacy to your business. It is an intangible benefit, but when the business credit card company approves a business credit card for your small business, it gives a signal to other merchants that your business has good, sound credit. A business credit card is a very credible imprimatur.
For the start-up small business, or one which has a tarnished record, a business credit card allows your business to build or rebuild a credit history. By ensuring that this credit history remains consistently positive, you will establish the foundation for securing a business loan or line of credit should you decide to expand the business in the future. The business credit card is your guaranteed line of credit for now.
Monthly business expenses are easier to track with a business credit card. The monthly business credit card account statement helps with the reconciliation of the purchases you make on behalf of your business.
The usefulness of the business credit card statement is not limited to tracking business expenses. It can also be used as a reliable and acceptable alternative documentary proof when you prepare your books and your financial reports for income taxation purposes.
Business credit cards and personal credit cards have similar benefits and rewards. When you have a business credit card, you will have a separate opportunity to enjoy discounts, cash back and rewards points on purchases of the goods and services necessary for your business.
When you have business credit cards issued to your employees, they can make purchases on behalf of your company without advancing their own funds, or use the business credit cards when they travel for business. Their use of the business credit cards makes it easier to account for expenses.
When you charge purchases to business credit cards, you get the chance to enjoy cash discounts. Companies that supply business-to-business products normally give significant discounts when the purchase is paid for in full upon purchase. If the purchase is on credit, the discounts are smaller and calibrated according to the financed period. Charges to your business credit cards always count as cash purchases, since your business credit card issuer will take care of paying them shortly afterwards.
The purchases you make on your business credit cards may qualify for special insurance protections from the business credit card company. In case something turns out wrong with the item you bought by means of your business credit card, and the merchant is not willing to return your money, the insurance protection will cover the amount.
There is rightful concern about the high interest rates on business credit cards. Suffice to say that these are still lower than rates on merchant credit. If you make effective use of the float period, then pay off your balance in full each month, you actually avoid paying any interest at all. If you plan to carry a balance, make sure you find the business credit card with lower interest rates.
The rewards business credit cards give great benefit when you do a lot of travel.
In short, it makes good business sense to have a business credit card or two at your disposal.
Why Bankruptcy May Not Always Be The Best Option When In Trouble
It’s a sickening feeling when your debts start to stack up, your marketing strategy is failing, and it doesn’t look like you’ll ever be profitable. Your family is getting stressed, your business can’t pay its bills, and customers are starting to make angry phone calls asking why the things they paid for aren’t happening.
At this point, many people feel ready to throw in the towel. I’m here to tell you why you shouldn’t be one of those people.
A Proverb.
There’s an old Chinese proverb I’d like to share with you: the temptation to quit will be greatest just before you are about to succeed. Nowhere is this more true than in home business. You might feel like you’re failing over and over again, until you feel like giving up. The paradox, though, is this: you haven’t really failed until you’ve given up.
Never Fear.
If you really want to, there will always be ways to raise money for your company. You probably have all sorts of bills for things you don’t use, not to mention possessions that could be sold or downgraded. Did you know that the average person has thousands of dollars worth of random stuff just lying around in their home? In other words, you can always find the money if you’re really determined and not afraid of losing everything.
The only thing you should really try to protect is your house and some money for basic food — everything else is expendable. Never forget that the worst thing that can really happen to you is that you’ll have to go out and get a job. Would that really be so tragic?
Fear is your enemy in business. You cannot give in to your fear and give up before you’ve given it your all — the real reason why so many home and small businesses fail is that their owners chicken out and run away at the first sign of trouble.
The Captain Goes Down with His Ship.
When the chips are down, the only thing to do is to stake your personal success on the success of your business. After all, what’s the point in bailing out before you have to? You’re guaranteed to lose money that way.
Someone once told me that the difference between an average Joe and an entrepreneur is this: the entrepreneur will not give up on a business until his creditors come and take everything he owns. And even then he might try to hide from them and keep things going from his friend’s basement.
Don’t Tell Customers.
It might seem dishonest, but for goodness’ sake do not tell any of your customers that things are going wrong because your business is in trouble. They will immediately run a mile, putting your business in a far worse situation than it was before. You must always try to make it look like everything is going just fine — admitting problems will put the final nail in your business’ coffin.
Try a Voluntary Agreement.
If your creditors are at the point of knocking on your door, you should try to get a voluntary agreement with them before you even consider declaring bankruptcy. This is when you negotiate your debts down to a lower level using the threat of bankruptcy, and your creditors sign an agreement with you to say that they will leave you alone once you’ve paid that money.
The Absolute Last Resort.
I simply cannot get across to you how much you should not consider bankruptcy as a viable option, ever, until you are absolutely forced into it. Think of it as being like suicide: the absolute last resort. Would you commit suicide because your business was going badly? I hope you answered no — which means that you shouldn’t consider bankruptcy either.
Having had a bankrupt company stays with you for a long time in everything you do: your credit rating, your employment history, and even just in the way you think of yourself day-to-day. It’s better to have everything wrestled from your hands than to give it up voluntarily — otherwise you’ll always be tortured by wondering what would have happened if you’d kept going just a little longer.
Many homeowners make the mistake of thinking re-financing is always a viable option. However, this is not true and homeowners can actually make a significant financial mistake by re-financing at an inopportune time. There a couple of classic example of when re-financing is a mistake. This occurs when the homeowner does not stay in the property long enough to recoup the cost of re-financing and when the homeowner has had a credit score which has dropped since the original mortgage loan. Other examples are when the interest rate has not dropped enough to offset the closing costs associated with re-financing.
Recouping the Closing Costs
In determining whether or not re-financing is worthwhile the homeowner should determine how long they would have to retain the property to recoup the closing costs. This is significant especially in the case where the homeowner intends to sell the property in the near future. There are re-financing calculators readily available which will provide homeowners with the amount of time they will have to retain the property to make re-financing worthwhile. These calculators require the user to enter input such as the balance of the existing mortgage, the existing interest rate and the new interest rate and the calculator return results comparing the monthly payments on the old mortgage and the new mortgage and also supplies information about the amount of time required for the homeowner to recoup the closing costs.
When Credit Scores Drop
Most homeowners believe a drop in interest rates should immediately signal that it is time to re-finance the home. However, when these interest rates are combined with a drop in the credit score for the homeowner, the resulting re-financed mortgage may not be favorable to the homeowner. Therefore homeowners should carefully consider their credit score at the present time in comparison to the credit score at the time of the original mortgage. Depending on the amount interest rates have dropped, the homeowner may still benefit from re-financing even with a lower credit score but it is not likely. Homeowners may take advantage of free re-financing quotes to get an approximate understanding of whether or not they will benefit from re-financing.
Have the Interest Rates Dropped Enough?
Another common mistake homeowners often make in regard to re-financing is re-financing whenever there is a significant drop in interest rates. This can be a mistake because the homeowner must first carefully evaluate whether or not the interest rate has dropped enough to result in an overall cost savings for the homeowners. Homeowners often make this mistake because they neglect to consider the closing costs associated with re-financing the home. These costs may include application fees, origination fees, appraisal fees and a variety of other closing costs. These costs can add up quite quickly and may eat into the savings generated by the lower interest rate. In some cases the closing costs may even exceed the savings resulting from lower interest rates.
Re-Financing Can Be Beneficial Even When It is a Mistake
In reality re-financing is not always the ideal solution, but some homeowners may still opt for re-financing even when it is technically a mistake to do so. This classic example of this type of situation is when a homeowner re-finances to gain the benefit of lower interest rates even though the homeowner winds up paying more in the long run for this re-financing option. This may occur when either the interest rates drop slightly but not enough to result in an overall savings or when a homeowner consolidates a considerable amount of short term debt into a long term mortgage re-finance. Although most financial advisors may warn against this type of financial approach to re-financing, homeowners sometimes go against conventional wisdom to make a change which may increase their monthly cash flow by reducing their mortgage payments. In this situation the homeowner is making the best possible decision for his personal needs.
For all people shop around for the best rate, there are few who have taken the time to sit down and add it all up. After all, why would you bother? The answer is that understanding just how interest rates work can help you see how important small differences in rates and payment amounts can be.
Interest Rates are Compound.
It is important to remember that what you owe is compounded – that means you pay interest on the interest you owe from the month before. That means that if you’re paying 2% per month in interest, you’re not paying 24% per year – you’re actually paying 26.82%. Charging interest monthly instead of yearly is a trick to make it feel like you are paying a very low price for your borrowing.
A Thought Experiment.
Here’s a question: would you rather have $1 million, or $10,000 in a savings account earning 20% per year in compound interest?
Well, let’s see how that $10,000 would grow. After 10 years: $61,917. 20 years: $383,375. 30 years: $2,373,763. 40 years: $91,004,381. 50 years: $563,475,143.
So after fifty years, you’d have over $500 million?! Well, not so fast. Of course, you have to take inflation into account – if we say inflation is 5%, then that money would have the buying power that $10,732,859 does today. Still, that’s not a bad return on your investment of $10,000, is it?
That’s the power of compound interest, and the way the credit card companies make their money (it’s also the way pensions work, and the reason the prices of things seem to rise massively as you get older). Be very, very afraid of compound interest. Or, of course, you could start saving, and be very glad of it
Compound Interest Adds Up.
Let’s work through an example on a more real kind of scale. Let’s say you have an average unpaid balance of $1,000 on a card at 15% APR.
You will owe $150 in interest for the first year you borrow. However, this amount is then added onto the balance, and interest is charged on that. The second year, you’d owe another $172.50, for a total of $1322.50. It goes on, with totals like this: $1,520.88, $1,749, $2,011.35.
After just five years at 15%, you’d owe double what you borrowed. And after 10 years, you’d owe four times what you borrowed! Bet you weren’t expecting that. If you let something like that carry on for long enough, you’ll end up paying back that credit card for years afterwards, paying back what you borrowed many times over and still not clearing the debt. Most people don’t work this out, and feel that the payments must simply be their fault for spending too much money to begin with.
One Percent of Difference.
One more thing. You might think there’s not that much difference between a card that charges 15% APR and one that charges 12% APR. Let’s see the difference the lower rate would make to that $1,000 borrowed for five years. Remember, after five years at 15%, you owed $2,011.35.
At 12%: $1120, $1254.40, $1404.93, $1573.52 $1762.34 after five years. So you’ve saved $249.01 from that 3% difference in APR – in other words, you’ve paid almost 25% less interest.