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Topic Summary

Posted by: meagher79
« on: May 28, 2020, 12:24:27 pm »

The key point is that the interest is charged each year regardless of the length of the loan.  Let's take a very simple example using "simple interest" instead of compound interest.  A $100 loan for one year at 10% interest would = $110 total repayment as you said, but a $100 loan at 10% interest for 5 years would = $150 because there is 10% interest each year. 

The situation you describe with the 5 year loan does not reflect the circumstances because the borrower gets the full $100 at the beginning and gets to use the $100 for five years (less the amount repaid over time which does reduce the interest). 

Maybe think of the 5 year loan as a series of one year loans.  Suppose on Jan. 1 of 2010, I borrow $100 to buy an airplane part.  On Jan. 1, 2011, I owe $110, but I'm not ready to repay, so I pay $10 interest, but I borrow another $100 to repay the first loan.  The first loan is done, but on Jan 1, 2012 I owe $110 for the second loan.  Again I get a new loan to repay the old one.  Each year I have to pay $10 for the use of the $100 I continue to have borrowed.  A five year loan just combines this process.  (Actually it gets more complicated depending on the repayment schedule and compounding interest.)

Try playing around with a loan calculator such as this one: https://www.calculator.net/loan-calculator.html
You are using the first option: Amortized Loan, where the principle is paid off gradually over the life of the loan.  As an example I looked at a $100,000 loan for 260 months in game.  The total repayment was $124,100 (which the game calls 24.1% interest rate, actually its the total interest)  I played around with the interest rate until I got the same total repayment and it was 8.85%

A very simple solution would be to just eliminate the shorter loans (they are a terrible deal compared to the 5yr), and change the "interest rate" label to "total interest percentage" as I suggested.  The actual 5 yr loan rate seems pretty reasonable. 
Posted by: patson
« on: May 27, 2020, 01:38:42 am »

Im not a loan expert here the rate we listed indeed in not APR

But im not sure if 5 years loan has much lower interest rate than 1 year lean? can you please explain it?

For example, if someone takes a $100 loan, and the 1 year rate is 10% and 5 year rate is 15%. I would supposed that the on 1 year term the total amount to repay is $110 and on 5 year term the total amount to replay is $115, it is true that on 5 year term, on average only $3 per year on interest, but at the same time the borrower really just getting $20 loan on average per year over 5 years period?

Posted by: meagher79
« on: May 22, 2020, 12:46:50 pm »

I just realized that the interest rate listed for loans is the total interest for the duration of the loan not the annual percentage rate (APR).  That means that 5 year loans actually have a much lower interest rate than 1 year loans!  There is no reason to ever take a shorter loan as it is.  An easy fix would be to change the label for "interest rate" to "total interest percentage" and then increase the interest on longer loans and/or decrease it for shorter loans.  Generally lenders require a higher rate for a longer loan because of the increased risk and because their money is tied up for longer.