Hidden Interest Rates & Where to Find Them
We obsess over interest rates. What we have to spend in total in excess of the sticker price or what we can earn on our money while we sleep is, understandably, of great interest to us. Pun intended.
Stay tuned for the most “interest”ing blog ever written.
When trying to grow our money, it’s an obvious strategy to try to get the lowest interest rates on things we buy and the highest interest rates on our investments. Despite this vigilance, two tricks have been played on us.
First, we have been unwitting thralls of the mathemagicians of finance. The real interest rates being charged on what we purchase are not what they seem.
Second, we have a self-imposed belief for what is the max possible amount to earn from any type of capital growth vehicle or investment. Generally, people don’t think it’s possible to earn much more than 10% APY. Even the most savvy investors have this belief inculcated into their thinking. Has this happened to you? Do you think it’s possible to earn 12%, 18%, 30% ROI? If you said: “No way!” then stick with me. You’re going to have your eyes opened!
Let’s start by deconstructing those real interest rates being charged by our friendly neighborhood department stores and the community banks up the road. A very carefully disguised financial racket has evolved right under our noses—and like any good magician does—we have been trained to “look here, not there” while we are being masterfully fooled.
Store Credit Cards
It’s probably a safe bet to say all of us have applied for and used store credit at some point. Store cards are a great way to finance big-ticket household items. Especially if you had a refrigerator break down unexpectedly and didn’t have money saved for just such an emergency.
Now, you’ve likely glanced at the fine print of a store credit card contract. Maybe the store has a “6-Month Interest-free Financing” deal. When you look closer at the contract, you will likely find that the interest is only deferred for a set time—say, 6 months. The fine print also says if your balance is not at $0 by the end of that term, all the deferred interest reappears and is applied to your balance—and now you will owe all of it.
In addition to that fun scenario is the card’s interest rate overall. Many purchasers will assume they can pay off the purchase in the interest-free period—and many do just that. In those cases, the interest rate never gets a chance to apply to you. If you have managed this, good for you! You beat the system! But many are not that fortunate.
Due to life happening, some will miss the deadline and get socked with not only the entire interest that has been accruing silently in the background, but also have to contend with outrageous APRs. Many store cards are north of 20%!
Here is an example from Lowe’s Home Improvement Store.
As of the time of this writing, Lowe’s has 6 Months Special Financing available*.
*Reference: Lowe’s Promotion
The fine print states—
“Offer applies to purchase or order of $299 or more on your Lowe’s Advantage Card. Interest will be charged to your account from the purchase date if the promotional purchase isn’t paid in full within six months. Minimum monthly payments required. No interest will be assessed on the promotional purchase if you pay the promotional purchase in full within six months from the purchase date. If you don’t, interest will be assessed on the promotional purchase from the purchase date.”
In other words, if you don’t pay off your balance within the 6 month grace period, the interest rate will be back-charged on the full purchase price regardless of how much has been paid off to date. But let’s look at the interest rate they are currently charging.
If you are a new account, here’s what they say—
“Standard APR is 26.99%.”
Wow! 27% return on investment!
Here is the finer point to grasp. No one seems to bat an eye when they see the fine print of a credit card or loan application stating that this “worst-case scenario” interest is this high. In fact, you may expect it. If you are like most people, you figure you’ll get it paid for in time and avoid any crushing financial blow. But that doesn’t always work out.
The truth is, because it is possible to successfully manage to avoid the large interest price tag, we tend to have a lot less fear of that high of a number. It’s a false sense of security however, because, as we’ve considered, things don’t always work out the way we hope and we get stuck making minimum payments with a 27% interest rate.
Do you feel that it would be impossible to find a vehicle that pays you over 25% APY to grow a nest egg? We just discovered that not only is it possible, Lowe’s has one going for themselves right now!
I’m not going to lie. This next one is going to hurt.
Currently, home-buying interest rates are at an all-time low. People are getting rate percentages from the low 3s to the high 2s. As was mentioned earlier, tricky math is hiding the real interest you are paying the bank.
The mystery factor is that whatever your interest rate is on paper, it compounds monthly—effectively increasing your interest rate substantially over time. You can only see this when you analyze what your final 30-year total payment amount to the lender is. Since it’s spread out over such a long time, it’s easy to miss. Generally speaking, by the end of a traditional mortgage, you practically pay double for your home. How can that be if your interest rate is only ~3%?
Before we dig in more, do you recall how to calculate the percentage of one number in relation to another?
For example, what percent of 10 is 6? In order to figure that out, you just divide the smaller number by the larger:
6 ÷ 10 = .60
Move the decimal two numbers to the right and you find .60 becomes 60%.
This simple math will dissipate the illusion of what our real interest rate owed to the bank is. When you have a mortgage, your payment stays fixed for the life of the loan, but fluctuating in that payment is the ratio you owe between principal and interest. Your monthly payment is heavily favored to pay interest in the beginning and only by the later years are you paying off the bulk of your principal.
This reverse interest-compounding payment calculation is called ‘amortization.’ As you pay off your loan principal, the amount of interest charged proportionally goes down too. However, the interest still compounds and that means it goes up at the same time it goes down.
Amortization is a way to calculate a monthly payment while your loan principal goes down, but the owed interest is still compounding. The reduction of principal coming from your monthly payments eventually outweighs this compounding growth and this is the reason for a steep reduction in interest owed the bank in the last ⅓ of your mortgage term.
Amortization calculators can easily figure out your monthly home payment with the following variable data:
- Amount of loan
- Interest APR
- Length of term
With the financial workings now under our belt, let’s see what the numbers really tell us. We’ll begin with the following sample mortgage scenario:
- Amount of loan: $300,000
- Interest APR: 3.50%
- Length of term: 30-year, fixed
In this case, your monthly payment would be $1,347.13. Of that amount, $875.00 goes to the bank as interest in your first payment. To get a wider perspective of what’s going on here, let’s now get a year’s snapshot of payment data.
[In our example, we won’t be considering taxes and insurance escrow that is generally included in a monthly payment. We are just looking at the principal and interest only.]
Monthly payment: $1,347.13 x 12 months = $16,165.56
Year’s worth of amortized interest payments = $10,408.22
Over the first year of your mortgage, you make payments totaling $16,165.56. Of that amount, $10,408.22 is interest alone, which is pure profit for the bank. Applying what we considered earlier about finding what percent one number is of another, we simply need to divide the smaller number (the interest paid) by the larger number (the total payment amount) to find out your REAL interest rate for the year. Are you ready for this?
$10,408.22 ÷ $16,165.56 = 0.6438
0.6438 = 64.38%!
In the first year of your mortgage, your interest rate is not 3.50%, it’s 64.38%!
I’ll give you a second to let that sink in.
“Okay, okay….but it gets better as my principal goes down each year right? It has to get to 3.50% soon after this!” you may be thinking. While your actual annual percentage rate does go down as you pay off principal, it is not as comforting as you may be thinking. Because your interest is still compounding the whole time it is reducing, you end up paying far, far more than the rate the bank advertised to you.
Here is a table of actual interest rates, taking into account the monthly compounding, for each year of a 30-year mortgage using the data from our earlier example—
|Yearly Interest Payment||Yearly Mortgage Payment||Actual APR|
Shocking? Surprising? Infuriating?
You don’t even get close to your advertised rate of 3.50% until the last two years! Even then, it’s only the very last year that you are coming out ahead!
While the banks aren’t technically lying to you, the real deal is being well-disguised under tricky math and calculations. If you refinance at any point along the way, you go all the way back to year one and resume paying the highest interest rates again. So much for the progress you made!
So, while one takeaway from this is bleak awareness of how much the banks are profiting off us, the thing I want to ask you is:
Do you think it’s possible to find an investment/growth vehicle that would net you a 30% APY? Look at the first 20 years of your mortgage on the above chart. The bank has found a way to create not only a growth vehicle that nets them more than 30% but the first 4 years are actually a 60% APY!! Let THAT sink in! Surely, high digit ROIs are possible. The banks have been using them on us for decades and decades.
The average APR on 30 years’ worth of actual APRs on a mortgage is 36.75%. If you could find a capital growth vehicle that would grow at that interest rate would you be happy? We know it IS possible. We just consider proof.
Banks & Fractional Reserve Banking
If benefiting in such a breathtaking way with mortgages wasn’t crazy enough, banks have another way to sneak in super-high interest earnings for themselves. They found a way to ‘stack’ interest rates using the same “chunk” of money in multiple ways at the same time.
Banks have been granted a special power by the Federal government that you and I don’t share. No, it’s not fair but there’s not much we can do about it other than learn about their dirty little secrets and find other great ways to emulate banking strategy with our own capital instead.
Banks can operate under what’s called “fractional reserve banking.” Put simply, fractional reserve banking allows the bank to lend out 10X the actual cash in their vault on any given day. Of course, this extra money only exists “on paper.” If a bank has one million dollars in its vault, it can lend out up to ten million dollars.
With this ability to create assets out of thin air, the bank can double-double-double dip, as it were. Say you deposit $100,000 in a bank. Ordinarily, the bank would now be able to lend out $100,000 for the various types of loan products they offer. But with fractional reserve abilities, they can turn that into $1,000,000 worth of loan opportunity for themselves.
With your $100,000, a bank will now have one million dollars on their books (but don’t forget there is only your original hundred grand in the vault). The bank proceeds to lend to customers that come along. They subsequently lend all of that million dollars out for various loan products in the following illustrated distributions:
Imagine these loans generate the following interest rates for the bank (using even numbers for simplicity):
- Mortgage = 3%
- Auto = 5%
- Construction = 7%
- Business = 10%
- Line of Credit = 5%
To determine an approximate rate of return for the bank, we need to add up all the interest rates. That comes to 30%. Right here, we have yet another example of a very high return on investment.
Perhaps you are now realizing that you’ve been trained to think it is not possible to earn double-digit returns so you don’t interfere with the banking players’ little money monopoly? Not true, is it?
But, we aren’t done yet. Thirty percent ROI on one million dollars is a gain of $300,000. Don’t forget that most of the money lent out actually doesn’t exist. It was created on paper by the fractional reserve method. What we TRULY have is the bank making $300,000 on your $100,000. The true ROI on the capital the bank raised with your money is…..300%!
Even if you come and take your money out, the loans the bank has outstanding as accounts receivable will still work to generate profit for them for years to come. Other people’s deposits will replace yours and become collateral leverage for the loans the bank has issued.
Now, imagine you could find a vehicle that could produce a 300% ROI for you! That would be amazing. Unfortunately, we haven’t found anything that good….not yet anyway (wink).
The takeaway information from this post is that while the general American public has been conditioned to think that the best ROI you can get is going to be around 10-12%, the banking industry and those that deal in lending have been profiting tremendously from our collective ignorance. We are kept paying them high interest rates and, at the same time, we are kept from earning high interest rates for ourselves. Meanwhile, the bank profits 300-fold on your money and what do they give you? Less than 1% on a savings account? We are being played, my friend.
The reason the word “lending” is bolded in the previous paragraph is because that is the secret you are not supposed to find out about. As the one fronting the money, a lender is entitled to profit off of that investment. Banks have covertly stepped into that role and shoved out the regular Joe. However, in the private lending space of alternative investing, you can take back your power, avoid or even step over the banks and make those high ROIs for yourself. You now KNOW it is possible!
Properly curated and vetted private lending opportunities can easily bring you upwards of 10-40% APY. At Position Yourself Wealth Strategies, we can educate you about these vehicles, show you how they work, put you in touch with the procurers, and help you create a strategy for attack to grow your capital and overall wealth. Make up for lost time. Take back the power that the banks have stolen from you. Contact us today and reserve some time to chat with one of us and we can get you well on your way.
You won’t believe what’s really behind the curtain!