Below is a guest post by Drewski. In addition to being my main squeeze he also used to work as a broker in New York City and currently helps teach brokerage exams. Aside from being uber qualified, as a graduate student he knows first hand the cold fist that is compounding interest. Read his thoughts on the subject below!
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I’m going to brag– I have pretty good credit. No outstanding debt and a pretty solid, albeit short, credit history. So I was pretty surprised when applying for a loan to pay for my MBA I was told my variable rate will be 2.5% above the prime rate. I was expecting to pay the prime rate, or maybe a little over. This is not the good kind of surprise.
Now for y’all who don’t know, the prime rate is essentially the lowest rate that all the banks agree upon. So basically all the banks talk amongst themselves and agree to not compete with each other by setting this rate. That rate is currently at 3.25%. It has been since 2008 and doesn’t look like it’s going up any time soon. And just for reference the discount rate(the rate at which the banks are able to borrow from the Federal reserve) is at 0.75%.
Why did I choose a variable rate over a fixed rate? Well interest rates don’t seem to be going anywhere anytime soon. Ben Bernanke seems to think that low interest rates are the key to recovery. While he is the federal reserve chairman, or until he changes his mind about all of his policies, interest rates will be low. Until of course we recover economically. And since a lot of our issues are tied globally to Europe, I think it’s pretty safe to say that my rate of 5.75% isn’t going anywhere anytime soon. And if it does creep up before this is all paid off it has a ways to go to catch up with the Stafford loan fixed rate of 6.8%
So why did I choose a Discover loan? Basically they hook you up. Upon graduation I get 2% knocked off my principal. Of course interest is accruing from the point I pick up my check so if I take $50,000…. I would get $1,000 taken off the loan when I graduate. Of course I would have racked up almost $6,000 in interest due! But I’ll still take that $1,000.
The main point of this piece is to look at the actual cost of those interest rates. As an out-of-state student my tuition per semester is $16,052 (Although I’m still waiting on the results of an out of state tuition waiver…) I’m taking out two loans for my first year. One in the fall and one in the spring. Each loan is for $22,596.50 which will cover tuition plus my living expenses. At the end of the first semester that $22,596.5 will have turned into $23,130.45. And at the end of the spring semester, my first full year will cost me 46,591.50. That’s an extra $1,400 in interest added to the cost of my first year of school.
Now, I’m planning on doing anything possible to make sure I have an assistantship next year, so lets just assume that goes according to plan and my second year of grad school is free. At the end of my second year, my first year loan will have magically transformed to $49,269. That’s an extra $4,000 just upon graduation when I can hopefully get a job to finally pay this thing off.
There’s no way for me to know how much money I’ll be earning when I do find a job, so it’s tough to calculate exactly how much I’ll be paying in interest on this loan. But it’s very important to realize that if I am fortunate enough to be earning so much money that I can pay it off in the first year it will cost me $52,101. That comes out to about $7,000 in interest. If you’ve been keeping tabs you can see that the first year cost me $1,400 in interest. The second year cost me another $2,600 and the third and ‘final’ year will cost me $3,100 in interest while I finish paying the loan off. This is the magic of compounding interest. It will keep getting exponentially higher unless you start paying the debt off faster than interest accrues.
No wonder the country is suffocated by debt. Real costs are staggeringly higher than stated costs. And those alone are pretty damn high.
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Thanks to Drewski for the guest post! In case you missed it check out the guest post I did for Canadian Budget Binder yesterday entitled “Going to Private School Affected my Finances”.
CARNIVALS!
Carnival of MoneyPros at Finance Product Reviews
Carnival of Retirement at Debt Black Hole
Nerdy Finance Carnival at Nerd Wallet
Wealth Artisans FinCarn at Wealth Artisan
Y & T’s Weekend Ramblings at Young and Thrifty
Yakezie Carnival at See Debt Run
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