Whether it be a student loan, a new car, credit cards, or a mortgage, it’s easy to fall into the trap of purchasing something or opening a line of credit just because you can afford the monthly payments. I use the word trap because, sometimes, we tend to have a hard time conceptualizing the full picture if some of the bigger details are laid out in very small print.
In society, the focus is placed more on how much you can afford in monthly payments rather than how much something is going to cost you in the long run; that is why interest matters.
The devil, as people say, is in the details. The details, are generally the things we don’t pay much attention to when the shiny new toy we’ve been wanting is within a signature’s reach of being ours for the low price of $999.00 a month! When you can afford the monthly payments, who cares how much it cost, right?
To illustrate why you should pay attention to interest rates, let’s dive into the totally fictional story and life of Jake Doe. Side note: I want to apologize in advance to any Jake Doe out there that thinks this story may be about them. Again, although this story may hit home, it is a completely fabricated piece of literary fiction for illustration purposes only.
Jake Doe is your average run of the mill millennial (someone born roughly around the early 1980s to the late-1990s, early 2000s depending who you ask). Jake graduated with student loan debt, has a few open credit cards he uses for random things, owns his car (an old Toyota his parents gave him as a gift), and recently purchased his first home because the timing seemed right.
The story begins in 2000 when Jake graduated from high school and realized his parent’s couldn’t help with college tuition. So, naturally he did what any kid in his position would do, he explored a few options, applied to a few scholarships, but ultimately ended up taking out a student loan. Fast forward four years to when Jake graduated with his B.S. degree in Computer Science. For the sake of this illustration, let’s say he also graduated with, according to a *US News article on the graduating class of 2016, $37,172 in student loan debt.
**Interest taken from US News Article on Student Loan interest rate cost.
It only took Jake a few weeks to land a decent paying job as a junior computer programmer. He quickly settled into his new life as a young adult and once his 6 month student loan grace period was up, he started making the minimum monthly payments towards his loan. Jake didn’t really have a game plan in place to get his loan paid off quickly, in fact, he barely looked as his bill. He put his payments on auto-pay and much like the saying “set it and forget it” goes, he did just that.
At Jake’s job one day, he overheard a few of his coworkers talking about how they flip houses on the side and because the market was so hot, almost anyone could get approved for a mortgage. Jake’s coworker told him the best time to buy a house was right now and he didn’t need to come up with a 20% downpayment because everyone was getting approved. At that point, Jake looked into a few things, went down to the bank and got approved for a mortgage.
He went 30 year-fixed mortgage would be his best option since the monthly payments were much lower than a 15 year-fixed and after all of his other bills, he had just enough to cover the lower payment.
Jake hadn’t done much research, so he figured that as long as he could afford the monthly payments he was fine. Houses with three bedrooms, two bathrooms were all within the price range of what he got approved for so Jake went for it, even though he didn’t need all that space. He figured that bigger is better and eventually he would meet someone to marry so why not?
Everything was going great for Jake, he was on the fast track to the corner office with all the trimmings of success to show for it, that is until the market tanked in 2008. Jake found himself in a bit of a rut with a pretty hefty student loan hanging over his head, a mortgage, and talks of layoffs at his job. Thankfully, Jake’s position was spared, but since the company was strapped for cash, they sent a notice out to all the remaining employees to inform them that no bonuses would be given out at the end of year. Jake had become accustomed to receiving the extra cash over the years so when the holidays rolled in and his bonus wasn’t there to help gifts, book lights, etc, he got a credit card. After a few expensive gifts, a few flights to see his folks, some new work clothes, and one student loan payment, Jake’s purchases started to add up.
As usual though, Jake began to make the minimum monthly payments on his credit card, his mortgage, as well as his student loan. He figured the monthly minimums were pretty reasonable and since he could afford it, he wasn’t doing too bad for himself (insert pat on the back).
According to an article on Nerdwallet.com* on credit card debt, the average Household Credit Card Balance in 2016 was $16,883. For the purposes of this example, let’s just say Jake is carrying a credit card balance of half that amount which would equal $8441.50.
You see, Jake didn’t really have much saved, he paid little attention to how much he was paying in interest, he wasn’t on a budget, and he rarely thought about planning his money for the future. Eventually, Jake’s employer had to close their doors because of the downturn in the economy and once again, Jake found himself in an even bigger bind.
Since being laid-off, Jake started to pay more attention to his bills and where his money was going. He felt like he was making progress on what he owed, but for some reason the needle never seemed to move. Jake thought to himself “how could this be? Each month I’ve been making regular payments for years now and the amount I owe looks the same.” Jake’s anxiety started to grow and he began to feel like it would take him a lifetime to pay off all his debt.
You see, this is why, how much you pay in interest, matters. Jake could be you or I, he could be your next door neighbor, classmate, family member, coworker, or friend. Jake represents the average american who works hard, buys a few things on credit, and doesn’t have a ton saved. Jake was always one or two paychecks away from the brink of disaster but like most people, he never thought that anything would happen to him because technically he could afford it right?
Having a high interest rate, is like dropping money into a large black hole. While the payments may be manageable, similar to how Jake felt, the needle just never seems to move. All things being equal, when you only look at how much you can afford each month in the short term, you cheat yourself in the long term.
Ever heard of the saying “Death by a 1,000 paper cuts”? Well change that to “Death by a 1,000 minimum monthly payments” and you’ll get what is being conveyed here. In one year, if Jake strictly followed the semi-aggressive payback plan of Scenario 1, he would have paid over $6,000 dollars in interest. Jake would have paid even more interest, if he had based his repayment plans on scenarios 2 or 3. Not to mention, in this illustration, Jake owns his car. If you were to factor in a car payment, on top of all this, the sky would be the limit!
For these very “normal” normal debts, over the course of his obligation to pay them back, Jake would have paid a total of $192,241.84 in interest for STUFF that initially cost $295,613.50 at the point of purchase based on Scenario 1 (factoring in a 30-year fixed mortgage instead of 15 year-fixed).
Think about how much almost $200k could help you in retirement, about how many things you could have bought in cash instead of on credit, think about how much interest you would have saved if you consciously decided to live below or within your means and went with 15 year-fixed mortgage instead. This is why interest matters. While some of these debts may seem necessary at the time and are your best option, that doesn’t mean that you shouldn’t be doing your best to minimize your losses.
Rushing to open a store credit card or not having the patience to wait for a home to come on the market that is within your price point will hurt you in the long run if you aren’t careful. Everything will always seem normal, manageable, and just fine, until its not. This is why, paying attention to how much you pay in interest, should matter to you. It all adds up in the end and is usually the most crushing, during the periods of your life when you already can’t afford to meet the minimum over an extended period of time.
I encourage you to revisit your interest rates, see how much you’ve already paid in interest, come up with a plan on how to tackle that debt faster before the interest tackles you, and STOP being normal.
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