Sunday, Aug 17, 2008
Cheaper Mortgages? Check the article's comments
Times Online: Ban compound interest to save the planet
Don't know how this one slipped through first time, but valid article it is.
Compound interest has been with us so long that we take it for granted. We borrow money and accept that we must pay interest to compensate the lender.
But look what happens. If we pay 3% on £100 then at the end of the first year we should pay back £103. If we fail to repay that then we must also pay 3% on the £103. This seems innocuous but the debt increases exponentially. A debt left unpaid, at 3%, doubles every 24 years. At 6% it doubles in 12 years.
And doing without money that was lent at interest didn't stop our predecessors trading, or building incredible monuments, from Westminster Abbey to the colleges of Oxford and Cambridge.
Posted by malct @ 09:29 AM (758 views) Add Comment
10 Comments
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1. plato said...
This compounding interest is certainly the 'killer' in the system. How about paying the interest up front. That means 5% fixed or whatever it is within reason. A 200k Mortgage would have 10K Interest. This would be paid off over say a period 2 years and the capital would remain outstanding. After this period compounding on the outstanding interest would come into effect and the capital still remains outstanding.
Once interest has been repaid the capital is then repaid over a fixed term with no further interest. Any shortfall in the capital repayments would be charged at interest.
Of course this would be calculated on a strict x salary basis..
Any Ideas?
2. Blindleadtheblind said...
stupid article. risk and reward for those willing to lend and those wanting to borrow, and very basic stuff that has been normal for thousands of years. Try changing it...and watch the result, lots more wanting to borrow and NONE willing to lend!
3. Ccamper said...
What a silly premise.
All you are doing with the £3 is choosing to lend that additional £3 the next year as well as the original £100.
There is no such thing as 'compound interest' as such - it's just a (usually annual) series of investment choices!
It doesn't matter that many investment vehicles are automatically set up to reinvest the interest earned - it's still a choice.
You could splash out with your £3 you earned on your capital or invest it.
4. plato said...
My comment at 1 is solely regarding first time buyers, I should have mentioned that. All subsequent purchases would come under the 'accepted financial system.' Whatever that is.
BTW :- 2. Blindleadtheblind said...
"NONE willing to lend!"................ I doubt that would ever be the case across the board.
5. brian t said...
Banks have shareholders that expect a return on their investments. If you tell them that they can't get that through the banks, they will do it elsewhere - a different industry or a different country. Mortgage lending is no different to other investments in this respect.
As for the idea of 5% interest up front: no. It would have to be more like 50%, to compensate them for the reduced interest over the lifetime of the mortgage. Look at what a mortgage costs YOU over its lifetime - 80-100% on top of the mortgage principal (less if you factor in inflation). Then understand that the Bank - and its shareholders - WILL make money off you, by hook or by crook. If you want to put one over on the banks, I see no alternative to a) borrowing for as short a term as possible, or b) not borrowing at all.
6. brian t said...
The article has a link to a more recent follow-up article - which is worth reading, if only for a laugh. Still, it raises an important point: the author is not anti-interest - calling it "rent for the use of money" - but anti-compounding.
Maybe I'm missing something, but: while I agree that compound interest can be a killer to e.g. African economies, I have to ask: why pay compound interest? If you pay the interest when you're supposed to, it doesn't compound. If you can't pay the interest, maybe you shouldn't have taken out that loan in the first place. You would think that the World Bank would not lend unless it knew the borrower could pay the interest on time.
I was going to say "imagine this happening in the housing market"... but I remembered that it IS happening in some places. Interest-only mortgages are common, but until recently I didn't realise that "negative interest" loans existed, particularly in the USA. The borrower pays only part of the interest on the mortgage, and the rest gets added to the principal, where - you guessed it - it gets compounded over time. These could only work on a cast-iron assumption that the sale price of the property - not its book value! - was going to increase sufficiently to make that worth the financial hit. I'll stop now before I start swearing. 8-\
7. mark wadsworth said...
If you don't like compound interest, take out an Islamic mortgage, end of.
If the gummint, who never understand The Law of Unintended Consequences were to legislate that compound interest is illegal (and they are so stupid and so gimmick-happy, I wouldn't put it past them), banks would only lend money for the term of one year, after which it is to be repaid in full, or remortgaged.
If you've been a sensible borrower and repaid the £3 interest, when it comes to remortgage time, you owe £100 and so in year two you pay another £3.
If you have overstretched yourself and haven't paid the interest, after a year, you have to borrow £103, on which interest of £3.09 accrues in year two, and so on.
8. Sabine K Mcneill said...
As a mathematician I must say that compound interest is exponential and thus unsustainable.
As a system analyst, however, I see 'money' not only in my pocket but also in the tap that has its source and gets opened or closed. What's the source behind the tap? The government for Cash, i.e. interest-free notes and coin. Banks for Credit, i.e. interest-bearing blips in bank accounts.
Now I wonder why governments borrow "national debts" and New Labour sets up a "Debt Management Office" while some 20% of every annual budget consists of "interest payments". That's compounding interest on a scale slightly bigger your personal £100.
That's why we've launched our Public Credit Petition on http://tinyurl.com/666rwd in case you want to share the bigger picture.
More on http://forumforstablecurrencies.org.uk and http://forumnews.wordpress.com
9. inbreda said...
Quite right mark - and the reverse is also true. If you pay off £3.01, at the end of the year you only owe £99.99, and the next year interest is only charged on this amount, and it compounds in the same way such that without paying any extra a month you are able to repay the entire amount outstanding in one single payment. It's called a capital repayment mortgage.
10. Blindleadtheblind said...
Plato. You are right, but the point is demand / supply balance would be severely out of kilter, until of course the interest rates rose to entice lenders to lend...ergo the staus quo is resumed. Its all risk v reward at the end of the day.