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Interest rate is more than a figure.

What interest rate are you paying on your loan? When a financial institution advertises a credit facility, you will see something like “Interest rates range between 12% and 20%. The reality is that, only few people will get the loan at 12 per cent interest rate. In most cases, the loan will be given out at 20 per cent interest rate. The financial institutions usually have some modality for setting the interest rate that applies to individuals. Whatever the factor they consider, everything still bother about the credit risk of the person applying for the loan.

In order to determine the credit worthiness of an individual; financial institutions will consider your credit history, credit score and the amount involved among other factors. No lenders will give you the amount they know you will be able to repay. If the amount you are requesting for seems to be higher than what you have ability to repay, you should expect that the lenders will factor in the risk factor of the extra risk they are taking. Also, if your credit history reveals that you usually default in making payment, you should expect high interest rate. Another area of interest is your credit score, the higher your credit score, the lower the interest rate your lender will offer you and vice versa.

One would imagine why people having financial difficulty will be charged high interest rates while people who can afford to pay their debt enjoy cheaper rates. One will expect that the weak should pay low interest while the rich should be subjected to paying high interest rates. Well, the truth is that, when it comes to business, financial institutions don’t have that type of sympathy. They are into business. Business involves taking risk. The higher the risk; the higher is the likely returns. You may not like it but that is business for you. That is why the rich will be richer and the poor becoming poorer.  When the poor takes loan at a high interest rate; the burden to repay becomes high. This in turn may cause him to default in monthly interest and principal repayment. The default will be reported to the consumer credit agencies. This further takes tolls on his credit making his credit score to drop further. The vicious circle continues that way until things totally get out of hand.

Read Also: How to Get Your Free Credit Report

Let’s look at the two tables below in which two people secured a loan of $10,000 each at fixed interest rates of 12 per cent and 20 per cent respectively. For two of them to pay off the loans over 5 year period, see what their monthly payments and the cumulative interests are. The difference is just in the interest rates. You can actually use a loan repayment calculator to arrive at the same answer. If you use loan repayment calculator, you may not actually see the implication of paying high interest rates as demonstrated in the table.

TABLE A

Month	Loan Balance	Interest Rate	Interest Amount	Principal+Interest	Repayment Amount
1	10,000.00	0.12	100.00	10,100.00	222.44
2	9,877.56	0.12	98.78	9,976.34	222.44
3	9,753.90	0.12	97.54	9,851.43	222.44
4	9,628.99	0.12	96.29	9,725.28	222.44
5	9,502.84	0.12	95.03	9,597.87	222.44
6	9,375.43	0.12	93.75	9,469.19	222.44
7	9,246.75	0.12	92.47	9,339.21	222.44
8	9,116.77	0.12	91.17	9,207.94	222.44
9	8,985.50	0.12	89.86	9,075.36	222.44
10	8,852.92	0.12	88.53	8,941.45	222.44
11	8,719.01	0.12	87.19	8,806.20	222.44
12	8,583.76	0.12	85.84	8,669.59	222.44
13	8,447.15	0.12	84.47	8,531.63	222.44
14	8,309.19	0.12	83.09	8,392.28	222.44
15	8,169.84	0.12	81.70	8,251.54	222.44
16	8,029.10	0.12	80.29	8,109.39	222.44
17	7,886.95	0.12	78.87	7,965.82	222.44
18	7,743.38	0.12	77.43	7,820.81	222.44
19	7,598.37	0.12	75.98	7,674.35	222.44
20	7,451.91	0.12	74.52	7,526.43	222.44
21	7,303.99	0.12	73.04	7,377.03	222.44
22	7,154.59	0.12	71.55	7,226.14	222.44
23	7,003.70	0.12	70.04	7,073.74	222.44
24	6,851.30	0.12	68.51	6,919.81	222.44
25	6,697.37	0.12	66.97	6,764.34	222.44
26	6,541.90	0.12	65.42	6,607.32	222.44
27	6,384.88	0.12	63.85	6,448.73	222.44
28	6,226.29	0.12	62.26	6,288.55	222.44
29	6,066.11	0.12	60.66	6,126.77	222.44
30	5,904.33	0.12	59.04	5,963.38	222.44
31	5,740.94	0.12	57.41	5,798.35	222.44
32	5,575.91	0.12	55.76	5,631.67	222.44
33	5,409.23	0.12	54.09	5,463.32	222.44
34	5,240.88	0.12	52.41	5,293.29	222.44
35	5,070.85	0.12	50.71	5,121.56	222.44
36	4,899.12	0.12	48.99	4,948.11	222.44
37	4,725.67	0.12	47.26	4,772.92	222.44
38	4,550.48	0.12	45.50	4,595.99	222.44
39	4,373.55	0.12	43.74	4,417.28	222.44
40	4,194.84	0.12	41.95	4,236.79	222.44
41	4,014.35	0.12	40.14	4,054.50	222.44
42	3,832.06	0.12	38.32	3,870.38	222.44
43	3,647.94	0.12	36.48	3,684.42	222.44
44	3,461.98	0.12	34.62	3,496.60	222.44
45	3,274.16	0.12	32.74	3,306.90	222.44
46	3,084.46	0.12	30.84	3,115.30	222.44
47	2,892.86	0.12	28.93	2,921.79	222.44
48	2,699.35	0.12	26.99	2,726.34	222.44
49	2,503.90	0.12	25.04	2,528.94	222.44
50	2,306.50	0.12	23.07	2,329.57	222.44
51	2,107.13	0.12	21.07	2,128.20	222.44
52	1,905.76	0.12	19.06	1,924.82	222.44
53	1,702.38	0.12	17.02	1,719.40	222.44
54	1,496.96	0.12	14.97	1,511.93	222.44
55	1,289.49	0.12	12.89	1,302.39	222.44
56	1,079.95	0.12	10.80	1,090.74	222.44
57	868.30	0.12	8.68	876.99	222.44
58	654.55	0.12	6.55	661.09	222.44
59	438.65	0.12	4.39	443.04	222.44
60	220.60	0.12	2.21	222.81	222.44
	Total		3,346.77		13,346.40

TABLE B

Month	Loan Balance	Interest Rate	Interest Amount	Principal+Interest	Repayment Amount
1	10,000.00	0.2	166.67	10,166.67	264.95
2	9,901.72	0.2	165.03	10,066.75	264.95
3	9,801.80	0.2	163.36	9,965.16	264.95
4	9,700.21	0.2	161.67	9,861.88	264.95
5	9,596.93	0.2	159.95	9,756.88	264.95
6	9,491.93	0.2	158.20	9,650.13	264.95
7	9,385.18	0.2	156.42	9,541.60	264.95
8	9,276.65	0.2	154.61	9,431.26	264.95
9	9,166.31	0.2	152.77	9,319.08	264.95
10	9,054.13	0.2	150.90	9,205.03	264.95
11	8,940.08	0.2	149.00	9,089.08	264.95
12	8,824.13	0.2	147.07	8,971.20	264.95
13	8,706.25	0.2	145.10	8,851.35	264.95
14	8,586.40	0.2	143.11	8,729.51	264.95
15	8,464.56	0.2	141.08	8,605.64	264.95
16	8,340.69	0.2	139.01	8,479.70	264.95
17	8,214.75	0.2	136.91	8,351.66	264.95
18	8,086.71	0.2	134.78	8,221.49	264.95
19	7,956.54	0.2	132.61	8,089.15	264.95
20	7,824.20	0.2	130.40	7,954.60	264.95
21	7,689.65	0.2	128.16	7,817.81	264.95
22	7,552.86	0.2	125.88	7,678.74	264.95
23	7,413.79	0.2	123.56	7,537.36	264.95
24	7,272.41	0.2	121.21	7,393.61	264.95
25	7,128.66	0.2	118.81	7,247.48	264.95
26	6,982.53	0.2	116.38	7,098.90	264.95
27	6,833.95	0.2	113.90	6,947.85	264.95
28	6,682.90	0.2	111.38	6,794.28	264.95
29	6,529.33	0.2	108.82	6,638.15	264.95
30	6,373.20	0.2	106.22	6,479.42	264.95
31	6,214.47	0.2	103.57	6,318.05	264.95
32	6,053.10	0.2	100.88	6,153.98	264.95
33	5,889.03	0.2	98.15	5,987.18	264.95
34	5,722.23	0.2	95.37	5,817.60	264.95
35	5,552.65	0.2	92.54	5,645.20	264.95
36	5,380.25	0.2	89.67	5,469.92	264.95
37	5,204.97	0.2	86.75	5,291.72	264.95
38	5,026.77	0.2	83.78	5,110.55	264.95
39	4,845.60	0.2	80.76	4,926.36	264.95
40	4,661.41	0.2	77.69	4,739.10	264.95
41	4,474.15	0.2	74.57	4,548.72	264.95
42	4,283.77	0.2	71.40	4,355.16	264.95
43	4,090.21	0.2	68.17	4,158.38	264.95
44	3,893.43	0.2	64.89	3,958.33	264.95
45	3,693.38	0.2	61.56	3,754.93	264.95
46	3,489.98	0.2	58.17	3,548.15	264.95
47	3,283.20	0.2	54.72	3,337.92	264.95
48	3,072.97	0.2	51.22	3,124.18	264.95
49	2,859.23	0.2	47.65	2,906.89	264.95
50	2,641.94	0.2	44.03	2,685.97	264.95
51	2,421.02	0.2	40.35	2,461.37	264.95
52	2,196.42	0.2	36.61	2,233.03	264.95
53	1,968.08	0.2	32.80	2,000.88	264.95
54	1,735.93	0.2	28.93	1,764.86	264.95
55	1,499.91	0.2	25.00	1,524.91	264.95
56	1,259.96	0.2	21.00	1,280.96	264.95
57	1,016.01	0.2	16.93	1,032.94	264.95
58	767.99	0.2	12.80	780.79	264.95
59	515.84	0.2	8.60	524.44	264.95
60	259.49	0.2	4.32	263.81	264.95
	TOTAL		5,895.86		15,897.00

Read Also: Important Facts about Debt Consolidation Loan

Effects of High Interest Rate

From the two table above, you can see how the your interest rate may be dragging you into debt. A person with interest rate of 12 per cent will only pay $222.40 every month to completely liquidate his $10,000 loan while the second person paying 20 per cent interest rate will be forced to pay $264.95 every month. At the end of the fifth year, the cumulative interests of the two individuals are $3,346.77 and $5,895.86 respectively. That is $2,549.09 difference. In most cases, when people are seeking loans, they don’t pay attention to the interest element. But with the table above, I think you will be able to what interest on loan can do to your finance. If you want to enjoy financial freedom, you will have to learn how to cut down your loan. If you have to take a loan at all, ensure that you negotiate the interest rate to the barest minimum. You will be able to achieve this if and only if you have a very good or excellent credit score. Therefore, you should avoid things that can damage your credit. The effects of bad credit is expensive.

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