Compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn’t, pays it.
Attrib. Albert Einstein, pull quote
Simple Interest Example: When you borrow money from the bank, they charge you interest. So, let’s say you borrow $100, and the bank says it will charge you 6% interest.
$100,000 * 6% = $6,000.
When you repay your loan to the bank, you will repay $100,000 (principal) + $6,000 (interest). So your total repayment will be $106,000.
Compound Interest Example: Now, let’s say you’re going to need a little more time to repay the loan. Let’s say you need 30 years (typical mortgage) to repay it. The bank punches the numbers and gives you a payment and terms:
$100,000 * 6% * 30 years
- Monthly payment = $599.55
- This is where most people stop. All they care about is the monthly payment. “Sure, I could afford that!” But keep reading the loan terms!
- Total borrowed = $100,000
- Total interest = $115,839.19
- Total payments = $215,839.19
OK, wait a minute here. Who in their right mind would pay $215,839.19 for something that cost $100,000? Apparently we all would. That’s how a mortgage works. But it doesn’t have to be that way.
Read on for TIPs on how to make your most expensive monthly bill your life’s absolute best investment!