Description

Getting a loan? Compute and manipulate thenumbers to your advantage.

The interest rate here has a name, it's called the APR (annualpercentage rate), this reflects the real time value of money.

Many reputable lenders cheat, they use a method, which prior to1940, was only used by loan sharks, called the rule of 78's.

The rule of 78s is different way of calculating interest in eachpayment. This method is called front loading. Meaning you pay moreinterest at the beginning of the loan than the time value of moneywould require. Why is this a rip-off?

Here is a thought experiment. If all the first payments areinterest and you payoff the loan early, you will pay the fullamount you borrowed plus interest that never accrued.

Here is an example: You borrow 10,000 and your payment is $200.Normally based on the time value of money a part of each payment isinterest. At first a little over half the payment is interest ($100approx.) declining over 7 years of the loan to the last paymentwhere the interest component is $0. The reason that the interestcost declines is that as you make payments the amount borrowedbecomes less making the interest owed less.

What if the beginning payments were all interest until all theinterest was paid after which you started paying off the amount youborrowed? At the end of 3 year you have paid off all the interestnow you can start paying of the loan. But what if you now paid offthe loan. You would have paid $6,800 interest plus the original$10,000 loan for a total of $16,800 instead of $4,000 interest(based on the time value of money) plus the original $10.000 or$14,000. You would have paid $2,000 extra.

Now the rule of 78’s in not this extreme, but you get theidea.

Mortgage lenders who make long-term loans (20-30 years) are moreup-front about it. The charge what are called points up-front,which is really just prepaid interest. Again if you pay off early,you paid too much. They count of this.

When we get married we think it will be forever. For car andhouse loans people change their mind every 3 to 5 years. Formarriages it's a little longer. So avoid the rule of 78’s andup-front “points”. Ask for a amortizing loan based on the timevalue of money with 0 points.

Double check what the lender tells you. What should the paymentbe vs. what they quote? What is wrong with their numbers? Let seewhat they are really doing. Enter the length of the loan, interestrate, and loan amount and compute what the payment should be. Putin their payment, press % to see what interest they are reallycharging you. This is powerful tool for manipulating the numbers toyour advantage.

Buy a house.
PV = 300,000
% = 3.75
N = 30 years
Press Pmt - to see the required monthly payment.

But what if you want a lower payment?

Enter the new payment (Pmt)
Press % - to see the required interest
or
Press N - to see the see the required years

What if you want to make the payments yearly, press the"Monthly" button several times to get to "Yearly", the payment willrecalculate.

The interest rate (%) and years on loan (N) are alwaysyearly/annual numbers.
The Pmt is Yearly, Monthly etc. Depending on the setting.

About the author: Having been a real estate broker for 40 years.I have seen all sorts of slimy lending practices. Armed with a toollike this is your best defense again getting robbed.