Current Interest Rates Mortgage Rates 3.5%-5.0% Credit Card Rates 12%-20% Prime Rate 3.25%

Interest Rates

Interest rate have a significant effect on expenses and profit levels

What's the big deal with interest rates? Everyone talks about them. Why are they so important? Well, the short answer is that the rate of interest is the price you pay for money. When you borrow money, the lender requires that you pay interest on the money borrowed. The about of interest is determined by the rate of interest.

The best way to illustrate what this means is with a few examples:

Mortgage Rates

Let's consider a hypothetical mortgage loan. If you were to buy a modest home for #225,000, after a down payment, your mortgage would likely be about \$200,000. If your mortgage interest is 6% and your loan is a fixed rate for 30 years, your payment would be \$1,199,10 per month. Of this, interest would be \$1,000 . The interest cost will decrease each month as your principal (unpaid loan amount) decreases. That first month you will be paying 5 times as much for the cost of money borrowed as you will be paying the loan off.

What if mortgage rates go down? How much will you save if you refinance? At 6% your payment would be \$1073.64. That gives a savings of \$125.46 per month. If closing costs are no more than \$1500 then you have a good deal. After that first year the savings are all yours.

Credit Card Interest

Credit card cost of money is usually expensive. The interest rate can vary from 8% to 36% per year.

Let's assume that you have a couple of credit card with interest rates of about 10%. You have a \$3,000 to \$5,000 balance. You can handle the payments just fine with your income. The "loan" is only costing you \$300-\$500 per year in interest costs.

Then the unthinkable happens. You lose your job. Six months later when you find a new job, your credit balance on your credit cards is now \$20,000. Because you were late on several of your payments, the default interest rate has reset to \$30% per year. The default rate is for bad little children that don't pay on time or are late making payments. Your cost for this very ugly loan is now \$6,000 per year of \$500 per month.

The credit card companies have used interest rates to kick you while you are down. This money pit will often require some outside help to get out of.

Your have a brilliant idea for a new business. You are able to convince your banker to lend you startup expenses of \$100,000. Your brand new business is on it's way.

Now after the second month your new business starts to generate a profit of \$4,000 per month after business expenses. You are really making some money, right? Not so fast. You have to pay the cost of money and the payment of the loan

Your \$100,000 loan at 9% for 6 years, has a payment of \$1802.66 per month. Your true spendable profit is only \$2197.45. For income tax purposes you can only subtract interest, not principal repayment. So for income tax purposes, your first month's taxable income would be \$3250.

Consider the effect that the interest rate would have on this business. If the rate were 6% the spendable profit would be \$2342.71. If the rate were 9% the spendable profit would be \$2044.96. Does that make it worth bargaining with your banker about the rate of interest to be paid?

Summary

Interest rate do matter. They are the cost of money. They influence the price you must pay for your home and for credit card debt. They also effect the profit levels for a business.

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