27 Apr The Interest Rate Doesn’t Matter!
This past week, I conducted a seminar on managing debt. I stressed the following three points.
1. Cash is king!
2. Before borrow, estimate the future value of the asset you are purchasing with your loan.
3. Keep your options open but implement your plan to quickly paying down your debt.
During the ensuing discussion, I demonstrated the impact one additional payment can have on a loan’s amortization schedule. We reviewed this in an early post, ’Picture Your Line of Credit – Part 2’. In my example, a $5,200 payment had the effect of enabling me to skip 17 regularly scheduled interest and principal payments saving almost $18,000 in mortgage interest. Instead of using my savings, I withdrew money from my line of credit. By using my line of credit, it cost just $4.38.
Instead of leaving my dollars in my checking account, I put my income to work 24/7. How did I do this? I immediately made a loan payment equaling my payroll deposit. I also scheduled my expenses to be paid at the end of the billing cycle of my line of credit.
When the seminar attendees saw this example, they were shocked. Someone asked me why would I do this if the interest on my line of credit is higher than my mortgage? My response shocked them.
The interest rate doesn’t matter! Why? My income lowers the balance on my line of credit. A lower balance means a dramatically lower average daily balance. This creates a very low effective interest rate. How low? We now have a low interest rate of 1.25 percent!
What’s the impact if instead of a 5.5 percent mortgage, the interest rate is 3 percent and the interest rate on the line of credit is 20 percent?
Without making any other changes to our living expenses, a three percent interest rate increases our monthly cash flow from $1,000 to $1,365.97, an increase of $365.97. This increases my monthly savings from $300 to $409.79 and the total withdrawals from the line of credit to $21,582. My total interest savings increases to $45,487 and the total interest I’ll pay for my line of credit will be $76.37.
If I want to lower my interest costs a bit, I haven’t spent the $856 of positive cash flow before I started this solution. Since my line of credit allows me to carry a credit balance, when I add this these dollars, my interest cost for the year drops to $39.64.
If the interest rate on my line of credit suddenly jumps from 4.5 percent to 20 percent, the total interest that I will pay on my line of credit increases to $176.17. Do I wish I had that I still had the lower interest rate? Of course! However, I’m still saving over $45,000 in mortgage interest.
Conclusion? The interest rate doesn’t matter. This arrangement is so much better than either earning .2 percent in a savings account or allowing my dollars to sit in my checking account doing nothing.
Start putting your lazy dollars to work. Learn from your bank, use your bank’s strategy to get out of debt and build financial wealth!
Ready to start your journey towards financial freedom? Get started today!
Thanks for joining me. I’d love to hear from you. Please send your questions, topics or suggestions to dennis@cashmapconsulting.com. You can also follow me on twitter at cash_map.
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