Can someone explain interest?

[Sheena815]

At the risk of sounding stupid (mathematical reasoning has always been a weakness for me), can someone explain how interest on a LOC works? Cause I don't think I'm getting it.

 

I'm sure my thinking is wrong, but all I can picture is, 150 000 total x 0.0475 = 7125$ in interest.

 

But then they talk about interest being "compounded" and "accumulating" and being charged as you go along..... I simply don't understand how it works at all!

 

Am I going to end up paying more than 7125 (hypothetically, assuming prime doesn't change)? If so, how on earth is interest calculated? I know its calculated on however much I transfer into my bank account right away... but that's all I get.

[KennethToronto]

I think $7125 in just interest is more or less correct?

 

Of course, it will be slightly higher if you are using the LOC to pay the interest.

[Wolvenstar]

Well on my $30,000 line of credit i am the 6.5% interest so I will use mine to explain it.

 

Now you only pay interest on what you take out. So if you withdraw all $30,000 you would pay $1950 for the year. If you have only withdrawn $1000 then you pay $65 for the year.

 

However LOCs don't do yearly payments they do monthly, so if you have withdrawn $1000 it's $65 for the year, but you make monthly payments of $5.42 (65/12).

 

 

The easiest way to figure out how much you must pay for the month would be to look at how much you has used up times it by the interest and then divide by twelve.

 

IE: used so far: $25,340

interest: $1647.10 ($25,340 x .065)

payment for the month: $137.26 ($1647.10 / 12)

 

 

I hope this helps.

[Sheena815]

Thanks guys.

 

So, basically, the difference is just in when I pay the interest, but overall its still going to equal the same amount (eg. 7125) overall over the 4 years?

 

If that's the case, I don't really see why it matters that much how much I transfer into my account and when. If it equals the same amount in the long run, does it really matter? The lady at the bank was saying things like "oh, just transfer the exact amount you need right before you use it, so you wont be paying interest on it all month, etc" but if it equals the same amount in the end, I really do not care.

[MillerTime]

$7125 in interest would be the interest accumulated in a year if you had used the entire balance of the line of credit ($150,000). Interest is only charged on what you take out of the line of credit, and is charged to you each month (but it starts accumulating right when you take it out of your LOC). So what is charged to you each month would be = (balance owing)x0.0475/12. The 4.75% is divided by 12 since it would be 1 month's worth of interest. The actual balance owing number would probably be some sort of average balance owing for the month (not sure exactly about this though). Now you can either pay off this interest each month, or some banks just increase the principal amount owing on the LOC. This would be the exact same as paying off the interest owed each month with money from the LOC, just less work for you if it's done automatically.

 

So say you have used $10,000 of your LOC. Interest for 1 month would be $10000x4.75%=$475 / 12 months = ~$39.60. If this was then added to the principle amount for the next month and assuming you spent no more money the next month, interest for the next month would be ~$10,040x4.75%/12=~$39.70, which would be added to the principle, etc.

 

Hope this helps!

[MillerTime]

I'm clearly too slow, but oh well. Anyways, 7125 would be how much you would pay per year if you had a balance of $150,000 the entire time. So say you took out all $150K at the beginning, your total interest paid after 4 years (assuming it was paid off each month) would be 7125x4=$28500.

 

Say I didn't use any money from the LOC for the first 3 years, then used all $150,000 for the last year, and paid off the interest each month, i would have paid only $7125. It all depends on how big your balance is on the LOC, and how long you have it for, because that interest just keeps adding up.

 

Thanks guys.

 

So, basically, the difference is just in when I pay the interest, but overall its still going to equal the same amount (eg. 7125) overall over the 4 years?

 

If that's the case, I don't really see why it matters that much how much I transfer into my account and when. If it equals the same amount in the long run, does it really matter? The lady at the bank was saying things like "oh, just transfer the exact amount you need right before you use it, so you wont be paying interest on it all month, etc" but if it equals the same amount in the end, I really do not care.

[Dal07]

In my opinion, if you don't need the money right then and there, then you shouldn't transfer it to your account. Like MillerTime said, you will end up paying a lot more in interest than you need to.

[Sheena815]

So say you have used $10,000 of your LOC. Interest for 1 month would be $10000x4.75%=$475 / 12 months = ~$39.60. If this was then added to the principle amount for the next month and assuming you spent no more money the next month, interest for the next month would be ~$10,040x4.75%/12=~$39.70, which would be added to the principle, etc.

 

Yikes. Okay, I knew there was something I was missing. This makes sense.

 

So, say I'm in third year, and I have spent 80 000, including the interest so far. Then would my interest payment that month be 80 000 x 0.047/12 = 316$?

 

On average, how much does the average person end up paying in interest on top of that 150K when all is said and done?

[medordie]

I believe the 4.75% is an annual interest rate, so the amount of interest you pay would depend when and how much of your LOC you use. For example, if you were to immediately take out $150000 in September of Year 1 you would be pay $7125 in interest annually.

 

If you use $30000 each year for four years of medical school you would owe approximately $1500 in interest the first year (30000 x0.05), second year $3000 (60000x0.05), third year $4500 (90000 x 0.05) and fourth year $6000 (120000x0.05), for a total of $15000 over the four years.

 

This is just an estimation since I was too lazy to use 4.75%, and really don't know much about finance, but based on this, I think interest will be higher than just $7125, depending on how you use the LOC. Please correct me if I'm wrong!

[MillerTime]

Yikes. Okay, I knew there was something I was missing. This makes sense.

 

So, say I'm in third year, and I have spent 80 000, including the interest so far. Then would my interest payment that month be 80 000 x 0.047/12 = 316$?

 

On average, how much does the average person end up paying in interest on top of that 150K when all is said and done?

 

Yep, you got it now.

 

As for the average, i have no idea, haven't even gone to get my LOC yet.

[MillerTime]

If you use $30000 each year for four years of medical school you would owe approximately $1500 in interest the first year (30000 x0.05), second year $3000 (60000x0.05), third year $4500 (90000 x 0.05) and fourth year $6000 (120000x0.05), for a total of $15000 over the four years.

 

This is correct, but only if you took out the entire $30,000 at the start of each year. Otherwise, if took out $2500 per month, adding up to $30,000 for the year, you would pay less than $1500 interest for the year.

[KennethToronto]

If I'm not mistaken, LOC compounds daily, not monthly. Hence, you should divide the interest rate by 365, not 12.

[Wolvenstar]

Well it might differ with the bank you go to, but I am with RBC and my LOC compounds monthly so yes divide by twelve. My payments are bang-on with my actual monthly payments.