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
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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