What to Know When Interest Rate Shopping

When I first heard the term volume of interest I thought this was some new buzzword to add another layer of confusion to the already overwhelming world of financial rhetoric. I was left scratching my head.

Over the years I have heard, read, and seen much ado about the rate of interest. It is easy to understand when shopping for a mortgage or a loan to immediately seek out the lowest rate. What very few people talk about is the volume of interest. In other words, how much interest will be paid over the lifetime of the debt in question.

I will illustrate this using some basic math regarding calculated interest servicing outcomes. My hope is to prove that when a financial institution allows us to complete a debt consolidation, it is not doing so because they love us and want nothing but the best for us.

Their end game is volume of interest and not rate. They are in the game of lending money for profit and therefore they never want you to pay off the debt. In that way, they can become richer than we think.

Now, let’s look at an example using a car loan of $20,000 for 6 years with an interest charge of 7.0% and a mortgage at 2.89% over 25 years.

Car Loan Amount: 20,000
Interest Rate: 7% per year
Loan Term: 6 years 0 months

You will pay:

Monthly Payment: 340.98
Total Payment: 24,550.56
 Total Interest: 4,550.56
Annual Payment: 4,091.76

Mortgage offer:
Mortgage Amount: 300,000
Interest Rate: 2.89% per year
Loan Term: 25 years 0 months

You will pay:

Monthly Payment: 1,405.53
Total Payment: 421,659.00
 Total Interest: 121,659.00
Annual Payment: 16,866.36

Here comes the new scenario. Say you’re having a bit of a cash flow challenge. You’re getting squeezed every month and you are looking for some relief. You go to your bank or mortgage advisor and ask about lowering your loan payments. Or you may want to re-work something to offer relief as you think this is a short-term challenge.

Your advisor immediately moves into their excellent training scenario of looking at re-calculating your mortgage to include your car loan.

They explain to you that your interest rate on the car loan is quite high in comparison to your mortgage rate and that you can reduce your monthly cost of borrowing if you could consolidate that loan into your mortgage. They request a moment of time to work out some numbers to show you how much this can benefit you.

They do some calculations and come back with an answer. The answer they give you has been set up so you say “yes” to it. But right before you do, think again.
By adding the car loan to the mortgage, you’ll be losing that loan payment of $340.00 and adding only $94.00 to your mortgage payment, a monthly savings to your cash flow of $246.00.

In addition, you are lowering your cost of borrowing on that $20,000 from 7.0% to 2.89%. What a deal! You’re smiling, the banker is smiling, and the shareholders of the bank are smiling also. Here is why.

Your mortgage will now look like this:

Loan Amount: 320,000 (up from $300,000)
Interest Rate: 2.89% per year
Loan Term: 25 years 0 months

You will pay:

Monthly Payment: 1,499.23
Total Payment: 449,769.00
 Total Interest: 129,769.00
Annual Payment: 17,990.76

Upon further scrutiny, the total interest cost (volume of interest) on your mortgage increased by $8,110. Your original car loan was set to cost you $4,550.56. The cost of that car loan has just been increased to a total cost of $8,110, an increase of $3,559.44. This is volume of interest—this is where the true cost of your borrowing is factored.

We don’t like debt consolidation and strongly believe that the first approach is to create a Cash Flow Plan. A Cash Flow Plan allows you and your Certified Cash Flow Specialist, (CCS) to see exactly how your money is flowing. By beginning with this approach you may find that you do not require a debt consolidation. You may find that there are other inconsistencies that are eating up your cash flow and can now look to build a better plan.

Start today with access to your free cash flow workbook.