If you focus on money, lending, interest and how it works, then you will end up making smart decisions about money consistently. Individuals always make mistakes with money, borrowing, and their future. In fact, the percentage of people making these mistakes is around 95%!
The idea is to avoid, or at least limit these errors, so you end up in financial independence or at least making a profit. All profits are positive, and they certainly beat losses.
The Beast of Amortization
The most prominent financial problem of our times is amortization, or, paying off loans. Traditional financial institutions, and now online lenders, have been using lending (amortization) to make obscene profits because either:
- People don’t care in a society of immediate gratification, or
- People are merely financially unaware of the damage caused by lending.
Our Monthly Lifestyle
Did you realize that we have been trained to think that life is made up of monthly payments? That means people who succumb to that lifestyle have entirely lost their focus on smart money decisions. If you take out a loan and the amount fits your budget, you just add it to your other monthly payment schedules.
A good example is the purchase of a car. When you step into a dealership the discussion never begins with the price of a car, it always starts with what are you available to pay monthly. This type of sale strategy, which is very effective, means the real cost of the car is sneaked behind monthly payments you can make.
The whole loan premise is worked around the APR (annual percentage rate). So we are in a way tricked into taking on more amortization through the discussion about the APR. The APR is a red herring, a way in which to fool you about getting comfortable in paying interest for as long as possible. What does that mean? Higher profits for the banks, lenders, merchants and credit card providers. If you did the math, you would see that over the term of the loan you will be paying a lot more than the APR. A lot more.
How Much Interest Did You Pay?
Let’s take an example of 4% APR. How much interest would you expect to pay on such a small interest rate? Do a quick mental calculation and estimate the answer. If 100 people were asked about that, nearly everybody would get it wrong. Take a $100,000 loan at 4% over 30 years, and you would be surprised, or rather shocked, at the amount of interest payable. Some answers included $25,000 or even $50,000 and a rare occasion someone guesses $60,000. No one ever assumes as much as $75,000 which is approximately how much interest would have been paid for that loan. The magic of compound interest works beautifully to make banks and lenders a great deal of money from your generosity.
You Need a Loan to Buy a Home
$100,000 is not the amount a person would borrow to buy a house. The average borrowings for a home is much closer to $400,000, and at 4%, work out the interest over 30 years. Most people might be unaware of that buying decision, but there aren’t a lot of alternatives to buying a home unless you are a millionaire and can afford to pay cash. Try to apply that principle to even smaller loan amounts, such as Payday Loans, Installment Loans, Instant Loans, car loans, and personal loans, and the amortization over any length of time is going to cost you money. And here’s a reality check: You are allocating your future unearned dollars! This is your money.
Back to the Future
Many people believe, incorrectly, that they are using the bank’s money and they are simply repaying it. Not true! You are bringing your money from the future to pay for the present lifestyle that you want to enjoy. Those future unearned dollars are being repaid with additional future dollars. This is defined as interest payments, and it is the usual penalty of spending your future earnings. Would you agree that every dollar you pay today is money that you will not have in the future? One can only hope that the asset appreciation over time, in the case of a house, compensate for the loss of money paid out on interest over time.
Appreciation and Depreciation
Everything else, apart from your home, is a depreciating asset. So, these items purchased with loan money means you don’t have that money available to help with wealth accumulation. If you don’t accumulate wealth, then your chances of financial freedom are limited.
It doesn’t matter how much money you save today if you continue to lose future dollars in the form of interest payments. The more monthly payments you have, the less you can save anyway.
Your money can…
In a way, you are compounding your losses because money can do only two things:
- Earn interest or,
- Pay interest.
The longer you pay on loans, the less money you have to help you achieve financial independence. Those people who have learned to deal with this secret of earning interest and building assets are going to gain financial independence.
And this gets us back to the earlier statement that only about 5% of people reach this lofty status. They have become aware of the basic knowledge of financial understanding, which includes:
- What is money?
- How does money work?
- What do you believe about money and the reasons for those beliefs?
For those of the vast majority who remain unaware of these basics of finance and the properties of money are heading for financial dependence at best. Without being too dramatic, many die penniless or wind up living penniless. The vast majority live with support from others such as family and friends, organizations, institutions, or if eligible and you live in the right country, government welfare. That is a form of financial dependence. Nearly 95% of individuals who reach 65 and over are dead, dead broke, or dependent on others to help them through the remainder of their lives.
No Money Smarts
All in all, that’s a sad state of affairs for a country that boasts about being the wealthiest nation in the world. Financial illiteracy is a significant problem, and the US has one of the highest rates. As a result, the country has that 95/5 dilemma just outlined above. More amazingly, this has been going on for over 100 years.
Choose Your Path
If you are more aware now of financial independence, you can take the necessary steps to make significant changes. Think of being at the fork of a road. One way leads to financial freedom, not a lot of traffic there. There are certainly speed humps along the way, but a slowdown and a careful negotiation will get you successfully over it. The other is the road to being financially dependent.
The decision depends on you taking the first step to financial independence. Do as much as you can to avoid paying out your future dollars that can be better used to build your wealth.
It’s true that we allow loans, lending, and payment of interest to form an integral way of life. Sometimes it seems necessary. But if you can lessen the impact by lowering your exposure, then you will reap the benefits a few years into the future.