Comments on: The Rule of 72 in Reverse – Helping Your Personal Finances

By: Craig

Craig — Mon, 03 Jan 2011 04:59:07 +0000

You're off to a good start. If you owe $5,000 and are charged 8% interest, then you will pay back $5,000 + $400 or $5,400. This is called simple interest. Unfortunately lenders add a new concept called 'compounding'. They will calculate your interest payments each year or each month or each day and add that to your balance. We'll use monthly compounding because most accounts work on a monthly cycle.
So we start by computing the monthly interest rate. If you're paying 8% annually, then you divide by 12 to calculate the monthly interest.
The first month you owe $5,000 plus the monthly interest of 5000 x (8/12) = 33.35
5,033.35 - 200 leaves a balance of 4,833.35 and you have paid $33.35 in interest so far.
month 2: 4,833.35 * (8/12) = 32.22
Add interest & subtract payment and your new balance is $4,665.57 (rounded off)
and you've paid $65.57 in interest so far.
Keep going & you'll find that because the balance increase a little bit before you make the payment it takes 29 months to pay off and will cost you a total of $488 in interest.

hopefully this will help get you started. Search for 'compound interest' and 'amortization table' to explore more.

By: Financially_Ignorant_But_Trying_To_Learn

Financially_Ignorant_But_Trying_To_Learn — Sat, 01 Jan 2011 20:47:31 +0000

I forgot to account for the interest payment in the 25 months, if 25 is for the principal, then how long should the interest be (as I assume total interest should be $400). Maybe I should just ask how interest works.

By: Financially_Ignorant_But_Trying_To_Learn

Financially_Ignorant_But_Trying_To_Learn — Sat, 01 Jan 2011 20:43:35 +0000

I am slow, (seriously this isnt a joke) tell me where my math is wrong (because I am overlooking something:

"Take two similar debts with the same starting balances of $5000, the same monthly payments of $200. They also have the same interest rate of 8%"

so we have Balance of $5000, payment of $200 and a rate of .08 correct.

5000/200=25 right, so shouldn't it take 25 months to pay this off (and that would be the 'principal' correct?)

Also, and this is where I am really confused (once again not a joke) but where does $488 interest come from? 5000*.08=400

So if this holds true then one should borrow $5000 and pay $5400 back in 25 months (I know it cant be this simple, that is why I am asking for help)

lastly (and this is a add on) for the credit card, according to the rule of 72, the balance will double in 9 years if not paid in full correct? 72/8=9.

If someone could explain this it would truly be a great help, so far nothing I have read or anyone I have spoken to has made this stuff clear.

By: barry econ

barry econ — Sat, 21 Jun 2008 15:54:23 +0000

interest on revolving credit is calculated more frequently often daily. Therefore a revolving debt with the same interest rate as a fixed debt will incur more interest and take longer to pay off.

Often if a cardholder is even one day late or does not pay off the balance on a revolving debt interest is charged on the whole amount. For example of you pay $450 off a $500 credit card balance interest will be charged on the full $500.

By: Craig

Craig — Wed, 02 Jan 2008 02:54:12 +0000

both good points, but you specify in your example that both interest rates were 8%
...and daily compounding doesn't make that much difference, you would lump it in with rounding error when you're measuring in years.

By: barry econ

barry econ — Mon, 31 Dec 2007 18:07:31 +0000

I think what I forgot to put in was that car loans typically aren't 19.9%. Actually, maybe it was because credit cards are compounded daily.....Thanks for the eyes.

By: Craig

Craig — Mon, 31 Dec 2007 16:52:13 +0000

While the concepts presented here are sound, the math is atrocious.

$5,000 paid off in $200 payments will be paid off in 29 months no matter whether you're paying your car dealer or your credit card company. It will cost you $488 in interest which is the only part of that example the author got right.

$7,000 paid off in $200 payments will be paid off in 40 months at 5.9% interest at a cost of $701
The 'personal loan' calculations are right, 41 months at a cost of $961.

Revolving debt can be very dangerous, but it refers ONLY to your choice to put more debt on the card. If you are making monthly payments and NOT using the card, then there is no difference in the types of loans.

Take the author's advice and don't keep using your credit card when you're trying to get out of debt, but go somewhere else for help with your math homework.