The True Price Of Money
Everything costs something, even money. The price of money is the interest paid. In the case of your “idle” funds (savings account, money market, CDs, savings bonds, etc.), you want to be paid for someone else using them. When you borrow money (mortgages, car loans, credit cards, etc.) the bank wants be paid for your privilege of using their money.
It is important that you know the interest rate you get or pay for money. If you know what that true interest rate is, it is easy to make a comparison with other loan or savings sources.
The False Price Of Money
The problem is that you don’t always know the true interest rate. Banks and other financial institutions will often quote rates that are not the true interest rate. Their motive is to make their offering more attractive than it really is. Following are a few of their deceptive practices:
1. Points on a real estate loan. Points are, in reality, a form of interest. The interest rate quoted for the loan does not take into account the points. If you refinance or sell your home after just a few years, the points will make a significant increase in the real interest rate price of the loan.
2. A very low teaser rate for a fixed time. A local car dealer offers low interest and low payments. However, after 3 months the interest rate and the payment amount triples. The real interest rate can exceed credit card rates.
3. Credit card companies offer 0% interest for 6 months to 12 months for transferring your debt to them. At the end of that 0% period or if you are late on a payment (or even another creditor’s payment), the interest rate goes to their maximum rate of 25%+.
4. The worst offenders of all, are the payday or check cashing companies. They don’t state an interest rate, just a dollar amount. Their true interest rates can be as high as 500% annualized. Those are higher rates than the Mafia loan sharks charged in the 1930s.
5. When advertising rates for a savings account or a CD, banks will often quote an annualized rate. If the funds are not in the savings vehicle for more than a year, then the real rate you will receive will be less due to compounding. It should also be noted that if you withdraw funds from a CD before maturity, the bank will charge you an interest penalty, which will lower your rate of return.
In order to protect yourself from unscrupulous practices, you need to use a simple interest calculator to find the true interest rate on every loan or savings transaction. When you know the true interest rate, you can easily make a comparison with alternative sources to find the best deal.
Using A Simple Interest Calculator
Financial calculators are available online. They make it easy to input your data to calculate what interest rates you are paying or receiving. There are 3 kinds of calculators that you need:
1. A loan payment calculator. When you enter the required inputs of principle, term of loan, and interest rate, you will get a monthly payment. This is a good quick check to determine if the interest rate is correct. (Be sure to subtract all up front fees, such as points, from the principle .)
2. An interest rate calculator. This is similar to the above. However, you must input the monthly payment. The output will give you the true interest rate for the loan.
3. Compound interest calculator. When you enter the savings rate and the frequency of compounding (monthly, quarterly, etc.), the calculator will return the annual interest rate.
With these tools available you will know what the true interest rates are. You will be able to compare rates in order to make the best decisions for your financial future.