Here’s How Taking Loans Can Work Against Your Financial Success
In my last article that covered how compound interest works, I spoke about compound interest, its magic, and its role in helping you build passive income and lead to financial success, which is what Sleepy Money is all about.
In this article, I am going to cover the exact opposite of compound interest – DEBT INTEREST.
Unfortunately, today it’s “normal” to have debts.
When working to build up passive income, and a lifestyle where finances are not inhibiting your dreams, in most cases debts work directly against you.
According to Business Insider:
The average American debt totals $52,940. That includes mortgages, home equity, auto, student, and personal loans, plus credit card debt. Debt peaks between ages 40 and 49, and the average amount varies widely across the country.
While loans and credit enable you to purchase things you need, that you otherwise may not have been able to afford, they often work directly against the idea of investing and gaining compound interest.
Let me use some averages to paint an example.
Let’s say that between various loans, credit cards, and so on you have a $50,000 debt (just below the U.S. average).
And let’s say that you are paying back your debt with an interest rate of 15% (the average interest rate on personal loans being between 9.30% to 22.16% as of 2021).
And let’s say that you are paying your debt back over a 10-year term. Maybe your mortgage is on a 20-year term, while your car is on a 6, and so on, but for the sake of this example let’s average it out at 10 years.
On such a loan, your monthly payments would roughly work out to $806 a month, and by the time those 10 years are up, you will have paid $96,801 to borrow $50,000. That’s almost double!
Now let’s flip this. Bare with me…
Let’s take a look at what would happen if you would invest the difference in a solid investment that compounded your interest, over 10 years.
In the above example, you paid a total of $46,801 in interest over 10 years (120 months).
The average interest you paid was about $390 a month.
Now let’s say you hadn’t taken any loans and you instead put $390 a month into an account that incurred an average of 10% interest per year.
Which according to NerdWallet is the average interest an investment bears over time.
The average stock market return is about 10% per year for nearly the last century. The S&P 500 is often considered the benchmark measure for annual stock market returns. Though 10% is the average stock market return, returns in any year are far from average.
So, if you invest $390 a month, for 10 years, with an average interest of 10% per year you would wind up with $82,045.86.
Here you see clearly how loans and debts work directly against your financial well-being and freedom, while compound interest works directly with you.
But now let’s take it one step further. Let’s use the same example and say that you started investing those $390 a month when you were 28 years old and you did that until you were 50, 22 years.
By the time you were 50, you would have saved $367,581.
While I understand that you may be reading this and already have debts that you are paying off with interest, there are two things we can learn from this:
- Get busy and pay off your debts as soon as possible without taking on any additional debts that aren’t absolutely unnecessary and,
- It’s never too late to start setting aside a monthly amount into an interest-bearing account and allowing compound interest to help you work your way to making your money work for you!
Editor, Sleepy Money