The Rule of 72 Working Against You

Have you ever wondered why a $100,000 house will cost you $250,000 at the end of thirty years? They call it amortization, but it is the rule of 72 working against you. You may remember a post recently with an article discussing the rule of 72. Remember the rule of 72 says:

72 / fixed interest rate = number years it takes to double at that interest rate

Let’s use the example of a 30 year home loan with a fixed interest rate of 6%.

72 / 6% = 12 years (12 years for the money to double.)

A home loan will double 2.5 times with a 6% interest rate over 30 years.

30 years / 12 years to double = 2.5 times it will double

This is why a $100k home loan at 6% paid over 30 years will cost you $250k

$100k x 2.5 times = $250k

No, this doesn’t mean you shouldn’t buy a house, but it does mean you should make sure you loan will allow you to pay it off early without any pre-payment penalties. But the point here is actually not about home loans. The example of the home loan was to help you understand what I really want to talk about. Let’s look at how credit cards could be negatively affecting you right now.

The average interest rate being offered to on new credit cards right now is 13.17%. Let’s assume for sake of example that the rate is fixed, even though we recognized in reality it will go up.

72 / 13.17% = 5.5 years to double

If you had a credit card with a balance of $5,000 and you didn’t pay on it, it would be a $10,000 debt in five and a half years. But I make payments. Yes, you may, but many Americans keep charging on this card and paying off what they charged, but don’t end up paying on the $5,000. In that case you can be making regular payments, have a good credit rating, but be going further into debt each year. If this doesn’t describe you, that is awesome, but there are too many people for which this is true, and they’re often the ones that have a 20%-30% interest rate. Which, by the way a 25% interest rate only takes 3 years to double.

If this is you, the first step to changing it is to recognize what is happening. Now that you have the knowledge this is happening to you, you can make decisions accordingly.

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