Saw a meme with a guy paying back a $32,720 loan with a 30% interest rate and people in the comments said he’s gonna nearly 100 grand, or an extra 37k. How does interest actually work cause I’d assume the 30% meant 30% of the 32 grand?
In: Economics
Interest is typically expressed as an annual rate, not a fee over the lifetime of the loan:
In this case, with a 30% interest rate, each dollar borrowed that hasn’t been paid back will be charged 30 cents per year until it is
(In actuality, interest is usually calculated monthly or daily, but point still stands)
They will pay 30% of the remainder of the balance per year.
It really depends on the payments. If they’re paying $1000/month they will pay significantly less interest than if they are paying $200/month. The shorter the loan, the higher the payment, the less interest paid. Vice versa for longer length loans. If they paid off the entire loan immediately, they would owe little in interest.
Usually for home and auto loans, the loan is amortized. The principal and interest are calculated over a set period of time, then it gets divided by the time period in months to determine the monthly payment.
For credit cards, the interest is calculated daily, then multiplied by the number of days in the month to get a monthly payment.
Paying more than the monthly payment will greatly reduce the amount of interest owed over time. These are called principal payments. For home and auto loans, you usually need to specify you want to pay straight to the principal (not always, depends on the lender). For lines of credit, anything over the monthly payment will go to principal.
Depends on the type of loan. If it’s a student loan then it accrues interest daily. Every monthly payment pays down what has accrued since your last payment (assuming you are consistently on time, otherwise it all goes to interest on there plus whatever has accrued since then) plus a little towards the principle amount. Int calculated like… say student loan is 10,000 with a 8.2 interest. 10,000 x 8.2% / 365 is 224.64 move the point over two and it’s 2.25 rounded up. So the example would accrue approximately $2.25 a day. So in a 30 day period it would be about $67.50 a day. So you would be paying that much interest monthly… on top of what you are paying towards the principle to even lower the balance. So the end result is you end up paying a lot more than you take out. But again. Not all loans function this way.
Video games cost about $60. Since you don’t have $60, you borrow the game from me for $1 a day because you want to play it right away. It’s a great game and you really enjoy it, so you want to borrow it for a whole year. At the end of the year, you owe me $365 which is 6x the cost of the video game. Interest is the cost of borrowing money.
Edit: To add on, time is the bigger factor for the person you mentioned. 30% is very high, but how long the person is carrying the loan is significant.
It’s only “30% of the 32 grand” if the loan is for exactly 1 year, and the guy paid back the entire amount (plus the 30% interest) in full at the end of the year.
But most loans aren’t set up for that. Most people pay back loans in 3, 5 or even 10 years, while the 30% interest rate is charged on the remaining loan balance *each year*.
So it’s like 30% of 32k for the first year, plus 30% of the unpaid balance for the 2nd year, plus 30% of the remaining balance of the 3rd year, etc. etc. for 3, 5 or 10 years.
This adds up to a ton since you’re essentially paying interest on top of interest (on top of interest) — aka [compounding interest](https://en.wikipedia.org/wiki/Compound_interest) — for many years.
The actual calculation is a bit complicated since in reality loans are usually paid monthly in regular installments through a process called amortization. You can find many loan calculators on the web that can do this math for you.
For an example, let’s take a $32,720 loan with a 30% annual percentage rate that’s compounded and paid monthly for 10 years.
Plugging the numbers into a loan calculator, the above will result in a $862.56/month payment, over 10 years totaling (120 months x $862.56/mo) = $103,507.
That means the person will actually pay $70,787 in interest over the 10 years.
TL;DR: carrying balance on high interest rate loans or credit cards is *extremely* costly. Many people are financially ruined for life because of this.
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