Confounded Interest

The raft of advertising to release you from debt is incredibly cynical. Debt consolidation simply becomes more secure and permanent and the stranglehold just changes hands. Several smaller loans consolidated into a single BIGGER one. In principle:

1 + 1 + 1 + 1 = 4

But who benefits?

1 + 1 + 1 + 1 < 4

Only the lender, of course. After all it's still a loan, but simply a crudely disguised one. It doesn't actually help, but only appears to moderate difficulties. A benefit can be described as one that enables, say, a £1000 a month payment to service a credit card debt, being halved giving you an extra £500 to spend. Any sensible individual would at least use this "extra" £500 to pay off the debt. Not increase it. Any borrowing (or less paid back) involves extending the period where interest on the debt is charged.

Caveat emptor

Another cynical way of describing this is to redefine the situation. If a debt is converted to a loan by paying off the debt with a loan, the individual is no longer a debtor since a loan is now being repaid. It is still a debt, but no longer the original debt. That is now paid off and so non-existent. The borrower still owes money, but simply in a different way. Expensive semantics.

Interest is compounded and always the repayment of a loan is monthly. The interest is compounded 12 times a year. This means that interest is added each month to the interest already added (amortised). The next month interest is added to the interest of the previous month which had interest added the month before and so on. Interest added to savings is always paid once (annually), avoiding any compounding of interest.

The total is:

Paid out only once in a year

NOT 12 times in

Loans are serviced by the borrower 12 times in a year and even though compound interest is added to a reducing amount, the amortised interest ensures it climbs. Just not quite as fast as it's lowered.

Savings have interest added annually: compound interest is added to an increasing amount.

Such schemes are designed to maximise the repayment of a loan to the lender or minimise the burden to the institution that pays interest on savings accounts.

As an example, consider an amount of £25,000. If borrowed over a 15 year term at a nominal 8.15%, this would attract a total of £43,394. If the same (fixed) amount were to be invested with the same annual interest rate over this same term, it would result in 223.89% interest on the principal: £80,972.

If interest were added monthly and not annually, it would amount to a total of £84,542, but do not overlook the tax on earnings that will be attracted. Tax relief against tax payable.

On paper it looks like a reasonable option to borrow £25,000 and invest it all. As long as you have £241 to repay every month without touching the investment, the end of term balance sheet would indicate payments out as £43,394 and payment in at £80,972.

Presumably banks play this type of game. Lend money and invest the returns.

Be careful of the explanations of how helpful these lenders are. It's simple profiteering riding on the back of (your) misfortune. Tear up your credit cards and borrow wisely: if you really need to. Credit is so easy to obtain and the BIG sell is that we all really need the things that, in reality, we don't.

The hook is a BIG one and such a device will always be very uncomfortable to wear!

An Interesting Conspiracy
Virtual Money