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The Devil is in the Details
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Photo by Kyle Humfeld
THE SCENARIO
As happens with some regularity, I got a mailer from a company called 'Best Egg' this week, offering to lend me money. How lucky! The mailer touts this as a 'debt-consolidation' loan, with rates ranging from 4.99% to 29.99%*, depending on my creditworthiness (you'd think they'd have some idea of that before sending me such an offer).
Moreover, they charge you an origination fee of 0.99% to 5.99%, which is
deducted from the amount they give you. This means that if you borrow $10,000 and they charge you a 5.99% origination fee, they're only handing over $9,401, but you're paying interest on the full $10,000.
I know what you're thinking: this sounds awesome! Where do I sign up?
The question: If I were to borrow $10,000 from Best Egg for 10 years**, how much more would I pay overall if my loan were at 29.99% versus 4.99%? Assume monthly payments.
* If I were to consolidate debt to a 29.99% rate, that would probably be worsening my financial position - there
might be credit cards out there with 30%+ rates, but I don't have any of them.
** They don't disclose the maximum length of time you can borrow money from them in the mailer, but they do mention that loans with terms of 5 years or longer will have
at least a 4.99% origination fee, so I'm guessing that 10 years is an option.
THE SOLUTION
This one is pretty straightforward, and has a few parts:
- Find the total payments at 29.99%
- Find the total payments at 4.99%
- Find the difference
First things first, make sure the calculator is using 12 Payments per Year.
Part 1: The 29.99% Loan
N: 120 (The loan term is 10 years, which is 10 x 12 = 120 months)
I/YR: 29.99 (The loan's interest rate is 29.99%)
PV: 10,000 (Best Egg is lending me $10,000)
PMT: (This is what I'm trying to find)
FV: 0 (At the end, the loan is paid in full)
The monthly payment of
$263.54, multiplied by the 120 months I have to make that payment, is the total amount I pay on the loan.
The total amount I pay for the $10,000 Best Egg lends me is $263.54 x 120 = $31,625.29.
Part 2: The 4.99% Loan
N: 120 (The loan term is 10 years, which is 10 x 12 = 120 months)
I/YR: 4.99 (The loan's interest rate is 4.99%)
PV: 10,000 (Best Egg is lending me $10,000)
PMT: (This is what I'm trying to find)
FV: 0 (At the end, the loan is paid in full)
The monthly payment of
$106.02, multiplied by the 120 months I have to make that payment, is the total amount I pay on the loan.
The total amount I pay for the $10,000 Best Egg lends me is $106.02 x 120 = $12,722.00.
Part 3: The Difference
If I borrow at 29.99% instead of 4.99%, I pay a total of $31,625.29 - $12,722.00 =
$18,903.29 more for the $10,000 I borrowed (of which I only
received $9,400).
You may be wondering 'what about the origination fee?' Good question. The origination fee doesn't change the math by which I determine the monthly payment (or the total amount paid). The only thing it does is reduce the amount of money Best Egg gives me at the beginning - I still have to pay the whole loan balance.
I pay around 2½ times as much over the life of the loan if I borrow at 29.99% instead of 4.99%, and I pay around 8 times as much interest.
Clearly the details matter!
What do you think? Would you borrow money at 29.99%? What about 10%? What about 5%? What leads you to make that statement? Let us know in the comments!
