From Maura
We went over some of the homework and tried to unravel the issues around “e”. Some success, I think. Then we moved on to Chapter 10, loans. This may be the one chapter that students remember, if only because they found it a bit depressing (or so they told me). We started by talking about a fictitious mortgage for $200,000 at 7% interest, repaid at a fixed rate of $17,000 per year over about 25 years. We worked it out by hand for the first couple of years and saw how much of the payment goes toward interest and how little of it (at first, at least) goes to the equity or to the house. I stressed that this is a simplification: we are making a yearly payment, whereas most loans are paid back monthly; we aren’t including other costs such as insurance and taxes; and current interest rates are in fact better than 7%. Still, the point is to get the idea across. We opened the Excel spreadsheet that goes with this chapter and they saw how the numbers played out over 25 years. They were a bit stunned at the total amount paid in interest over the 25 year period – it was more than $230,000 on a $200,000 loan. Then we had a good conversation about why one would get in to such a scheme. Tax incentives, the value of owning your own home (both real and imagined), not paying rent, being able to (possibly) sell it for a higher price, and of course inflation. We didn’t do the math (it would be an interesting problem to work out) but certainly the value of the dollar will be much lower in 25 years, so the fixed payment of $17,000 may not be much of a hardship at that point.
I showed them how to use the spreadsheet to try different examples. A lower interest rate? Higher monthly payments? A larger mortgage? All were easy to imagine using the “what-if” power of Excel. We then talked about student loans and how that’s a similar situation. We did a couple of examples and experimented with different payments to estimate the time it would take to pay back a typical loan. The students were great with suggesting amounts and interest rates for me.
We talked briefly about credit cards and the important difference between monthly and annual rates; we also discussed the “minimum monthly payment” and how paying that minimum may put you into a situation in which you are paying a lot of interest. Recent legislation has changed how credit card companies must present this information – presumably for the better – but it’s still not a great idea to carry a balance on your credit card. I encouraged them to get a bank loan rather than do that. I also cautioned them to pay their loans, no matter what. Don’t let the envelopes from the loan company or the credit card company sit around unopened – that doesn’t make the balance go away. Pay what you can and negotiate what you can.
In the last few minutes we looked at the extreme example of the “payday loan,” a loan product (illegal in Massachusetts but widely available on the web) that typically charges 400% to 600% annual interest. Now the credit card interest didn’t look so high! We had a brief talk about this as an example of predatory lending. I should have talked about “rapid refunds” as another example of excessive interest.
From Ethan
Maura and I are both posting a day late. Sorry.
Gave up on further explanation of “e” – the homework solutions do touch on that, and it’s less important than other things we spend time on. In particular, today’s class was about debt: mortgage and credit card. We used the pay-off-debt spreadsheet to explore various scenarios. Yes, you often end up paying more in interest than the principal you borrowed when you took out a mortgage. But that’s not necessarily a bad thing. You didn’t pay rent in the meanwhile, and the value of your house or condo may have appreciated substantially. And the government paid between 15 and 35% of your interest (depending on your tax bracket).
Credit card debt is another matter. 1.65% intereste doesn’t sound too bad – until you realize that it’s the monthly rate. So pay your bills on time – and borrow money free from the credit card company. Maybe collect miles too. So how does the company make money? Interest charges on unpaid balances, and penalties – but, primarily, the fees they charge merchants (who are willing to pay them for the benefits of not having to deal with bad checks).
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