Loan Officer:  “Ma’am (or Sir), your application  to borrow $5000 unsecured has been approved.  Your payment is going to be $xxx.xx for 2 years at a rate of 11%.  I’ll just need your signature and you’ll receive your funds.  Thank you so much for doing business with us.”

Customer (like a deer in headlights):  “11%?!?! I thought the lowest rate was 9.5%?  Why so high?  I always pay my bills on time.”

Every one of us have had or will have to cross this path to get access to funds we need, but don’t have readily available.  Whether it be through loans obtained at banks/credit unions or by using credit cards, our goal should be to get approved and pay the lowest interest possible.  That way we keep the cost of doing business down to a minimum getting the best possible deal and saving money for other uses.

Let’s go ahead and discuss some of the major reasons why our cost of doing business becomes expensive.  Last week, I asked the question – “Why Do You Think We Pay High Interest?”  I’m happy to share the great responses I received along with my elaborations and additional reasons. 

Reason #1. “We don’t know any better…” -Gina, Gina’s Bookkeeping Service

Ignorance is not bliss.  If you’re not familiar with credit, credit scores and current interest rates, you can be told and sold ANYTHING.  The key is to negotiate (if possible), ask around, and check the internet for companies that track what the current rates are for a specific area of business (credit cards, auto loans, mortgage loans, etc).  There are also financial professionals waiting on you to ask them for their advice.  An educated shopper is a smart shopper.

Reason #2. “It depends on what you’re borrowing against…” –Daniel, Casual Kitchen

There are two different types of loans:  secured and unsecured.  A secured loan is when a borrower uses assets as collateral to decrease the risk assumed by the lender.  An unsecured loan is a loan that is not backed by any collateral.  It is just your signature and a promise to pay back the loan.  The risk for an unsecured loan is much higher than for a secured loan so you can expect to pay higher interest.  BUT you need to know what the interest rate ranges are for your level of credit (see Reason #1) to determine if you are getting a fair deal.

Reason #3. “Interest Rates fluctuate with the economy and status of the Federal Reserve Bank …” –Lakita, Personal Finance Journey

You can attempt to predict future rates by paying attention to what’s called the federal funds rate which is set by the Federal Reserve Board (the FED).  This is the rate that banks charge each other for overnight loans and is an early indication of the trend for longer term interest rates.  It’s basic supply and demand.   When the FED feels the economy is growing too fast, the rates are raised making it more costly to borrow money.  When the economy slows, the rates are lowered making it less costly to borrow money.  So if you can start noticing the trends of the federal funds rate, you can choose the right time to borrow money.

Reason #4. “We cannot wait…” –Eric, Eden Journal

Hmmm…impatience.  Yes, this is a great reason.  We can avoid the whole issue of paying interest just by saving up and using cash.  I do realize that this is a hard concept to apply to the large dollar amount purchases, but what about all the small purchases that we pay for with the swipe of a card.  The small purchases are actually the ones that do more damage because we pay for them over a longer period with compounding interest. 

Reason #5. “How much credit we have available and how often we use it…” –Susan Liddy, Secrets to Ultimate Living

This is actually funny, but when I was young, I used to think that having a lot of credit cards meant that you had lots of money.  But I think this concept was sold to me by television commercials.  If I remember correctly, weren’t there commercials on television that used to promote having many available sources of credit? The portrayal was of a consumer with a credit card that was not accepted, the spin was that the consumer would just pulled out another card to be used for the purchase.  The message was that it was “cool” to have many credit cards.

Well, those days are long gone.  The amount of credit available to you actually hurts your credit.  The risk is that you will use the available credit and not be able to afford to pay it back, which could then lead to a loss to the lender.  This has also led to many lenders closing accounts that have been inactive for a certain period of time.

Additional Reasons:

Reason #6.  Late pays, delinquent accounts.

This is an obvious cause for paying highly for the cost of credit.  Late pays and delinquent accounts appear on your credit as a “warning” to new lenders that you are a risk.  This new lender knows that you have the potential to default on repayment which prompts them to charge you the higher interest rate.

Reason #7.  Too many inquiries.

Another red flag to lenders…you’re shopping.  The inquiries show up on your credit immediately, BUT there is no way for the lender to know if you have been approved or denied which takes us back to Reason #5 – the total amount of available credit.  Lots of available credit equals a huge risk to the lender.

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As stated before, when it comes to borrowing money most times we cannot avoid the payment of interest.  We do have the luxuries of maybe using the “0% down” or the “Same as cash” plans, but that is credit dependent and a whole different animal.  The purpose here is to start making corrections in our credit profiles to lower our risks to the lender which lowers the amount of interest we pay.  $10 here, $20 there per month adds up to a lot of money over time.  I’d prefer to keep more of the money I’ve earned. 

It all boils down to this:  The higher the risk to the lender, the higher the rate for the borrower.

So, what say you?

• Do you pay the high cost of credit (high interest)?  Does this information help you to understand why?
• Have you overcome paying the high cost of credit?  What did you do to turn it around?
• Comments are encouraged and welcome!

Special thanks to the commenter’s who contributed to this article.  You guys are awesome!  And thanks to ALL OF YOU for reading.  I appreciate the time you spend here and I send you lots of love.

Don’t forget that education and knowledge about money is powerful so don’t forget to pass this message on to your friends. 

Have you ever really thought about what “interest” really means?  Have you ever calculated  the amount of interest you pay over the life of a loan(s)?  Or the amount you pay in finance charges per year on your credit card(s)?

Interest is defined as the “rent” you pay to borrow money.  We have all used interest at some point and time in our lives to make purchases.  Either the cash for the total purchase wasn’t available or we didn’t want to spend our cash all at one time.

The goal of many consumers is to pay as little interest as possible by either maintaining good to excellent credit and be rewarded with low interest rates OR by paying off debt early.

On the flip side of the coin, there are many consumers who have to pay higher interest as a result of mediocre to bad credit.  According to bankrate.com, interest rates today are as low as 4.72% for a new automobile to as high as 19+% for a Visa Credit Card.

I once read a statement by Anthony Robbins that stated, “In any moment, a decision you make can change the course of your life forever.”  If you think of this statement in reference to purchasing items on credit, how does it change your life forever?  The answer – Paying continuous interest robs you of future wealth.  Interest can be very costly in the present as well as the future.  Let’s look at a couple of examples…

The above are only two examples of situations where we pay interest.  But in reality, we pay much more due to purchases of homes, additional cars, continuous credit card charges and never paying off debt.

Not to get too technical, but we can calculate the future value of the two monthly payments above:  $701 per month, 20 year time frame, min 5% compounding interest = $250,000+ dollars.  So, investing $701 for 20 years would yield at least $250,000.  This is an example of your money working for you, instead of against you.

Do you want to now assess the damage of your particular situation?  You may click here to use the “When Will You Be Debt Free” calculator at CNNMoney.com to 1) determine how much interest you will pay on your current debt OR 2) a payoff timeframe estimate if paying off debt early.

We must develop power over purchase – instead of allowing our purchases and the people from whom we make the purchases to have power over us.  We must remember that we can always spend more than we make.  I once met a man whose annual income in one year increased from $42,000 to $175,000.  Both years he spent everything he made.  He had no sales resistance, no power over purchase.   – Dave Ramsey

How Can I Avoid Paying Excessive Interest?

I guess this would be the magic question.  How can I avoid the “interest” trap?

1. Use cash as much as possible.  The envelope system is a great method for this area.  When using solely cash, it’s either you have it or you don’t.
2. Plan for large purchases.   When planning for large purchases, shop around to compare prices versus taking the first item seen (which may be the highest price on top of paying high interest ).  The budget is a great resource for planning. 
3. Avoid spontaneous spending.  Because we are inundated with so many buy now, pay later advertisements.  It’s easy to talk ourselves into "just this time".  But we should refer back to Tip #1.
4. Pay off debt early.  The debt snowball method gives positive motivation to get out of debt quickly.
5. Have discipline. Last but not least, discipline is going to be what’s needed to change the buying habits that have been created over many, many years.

The ultimate challenge for any consumer is to eliminate or lower the amount of interest paid for purchases.  Speaking for myself, we are still paying interest on our home, but we are working toward a quick payoff.  I also will not say that I will never have to borrow money again, but I will keep the cost of borrowing down so that I have more to invest for my family.  I’m all about saving money…..how about you?