It might be time to apply for a loan | Patrick Smacchia
Today, I won’t talk about coding, while I see this discussion related to programmer’s life. If you read CodeBetter you are certainly a programmer, making and saving money with your coding skills and your energy. I’d like to talk about a few things related to money and especially loan. The point is that getting in debt is essential in life. In this time of crisis, where millions of people got ruined because of their loan, I don’t want to sound ironic. The secret is to get in debt with a fixed interest rate loan. The important word is fixed. Why? Because of inflation!
A word on Inflation
Inflation is the measure of the fact that the price of everything increase over time. Something that costs 2 bucks today, used to cost 1 buck a few years ago and will cost 3 bucks in a few years, we all know that. If you talk with your dad and ask the amount of salary he got, you might be surprise to hear it was a just a fraction of your salary today.
For example, your dad as an engineer was paid 25.000 US$ a year 20 years ago while you get pay 70.000 US$ today. 20 years ago, to purchase your dream’s house, a loan worth 8.000US$ a year over 20 years was enough. But today the same loan for the same house could cost well 30.000US$ a year. The amazing thing with fixed rate, is that, if today you were about to pay the last annual fee for your 20 years fixed rate loan contracted in 1991, it would cost only 8.000US$. If it was a variable rate loan, you could be well paying much more instead! So with a fixed rate loan, the higher the inflation is, the more you win. Getting in a long term fixed rate loan is the way to see inflation as something positive.
So what can we say about the near future of inflation? Nowadays, both US and Europe states got into an insane debt level. The US debt alone is worth 15.000 Billions US$ while something as ground-breaking and successful as Microsoft, Google or Apple ranges in the 100 Billions US$. The following famous picture represents the US debt stacked in 100US$ bills:
There is absolutely no way these debts will be honored properly. What could happen is debt canceling, which could provoke a war with say, China that owns a large portion of the debt. More preferably and more realistically, what will happen is that government will provoke more inflation. Nobody likes inflation, because it ruins people, corporations and economy. Remember? the only winners in case of inflation are those who have a lot of debts.
Actually during the last 25 years inflation has been kept low artificially, because states changed their strategy and borrowed to tiers actors like banks and other states, instead of borrowing to themselves. Indeed, before that period states used to borrow to themselves by provoking inflation. The result of this new strategy is the insane debts. More inflation is something governments know how to start, by printing more money, but don’t know how to stop. Hence they are still reluctant to go back again with inflation, but inflation is the only chance to give the global debt less value, and maybe get the head out of this situation one day.
If you look at historical US inflation, you’ll see low 3% to 5% rate since 1985, while it used to be up to 13,58% in 1980 and even more after the two world wars. I produce this US inflation graph from 1914 to 2010, from data available here, : http://inflationdata.com/Inflation/Inflation_Rate/HistoricalInflation.aspx
If you contract say, a 4% interest rate loan today, each future annual inflation rate above 4% will make you richer. And as said, there are serious reasons to think that inflation rate will grow insanely soon. Inflation rate above 10% has been reached not so long ago, this is clearly part of the possible.
Visualizing Compound Interests
Recently, me and my relatives had the chance to contract a few fixed rate loans, and I got pretty interested into the math beyond it. It is actually pretty basic math, but still, Einstein called compound interest: the greatest mathematical discovery of all time. To my disappointment, I found zero compelling offers on the web to quickly play with loan parameters (amount/term/rate) and get an immediate visualization of the impact on the loan cost. Weird but true: There is no good offer to visualize properly what is certainly the most important financial decision anyone has to take?!
This is why with a friend working in the financial area we created the free site http://www.loanfor.us/ in English and http://www.simulcredit.fr/ in French. At a glance, you can see that if you get a 20 years long loan for 300K US$, the loan amortization will look like that with a 4% annual interest rate:
And like that with a 8% annual interest rate:
And like that with a 12% annual interest rate:
The orange area represents the cost of the interest of the credit, while the green area represents the 300K borrowed. With an interactive calculator it is clear that the interest cost are not 4%, 8% nor 12% of 300K, which are 12K, 24K and 36K. The interest cost are 154K, 320K and 511K or 52%, 107% and 170% of the amount borrowed!
Imagine to give away 511K to have the chance to reimburse 300K!!! My dad said that 30 years ago, it was not exceptional that the interest cost could grow up to 200% of the amount borrowed. Of course, in these conditions assets like real estate prices are decreasing. On the other side, nowadays nobody is trusting finance and economy anymore, and with gold, real estate remains a compelling investment, which makes real estate price increasing. With these two opposite trending playing against each other, today nobody can predict how assets or gold prices will evolve.
Another interesting graph is the monthly repayments vs. the loan term vs. total credit cost, below in yellow.
There is a balance here, between short term high monthly repayments and long term high total credit cost, choose one. Because of the potential future high inflation, my bet is that long term like 15 to 25 years are preferable. It is also preferable because this way you can borrow more and purchase more and bigger assets today.
Thanks for following my reasoning; it is now time to go back to cool coding activity. But make sure to free up some brain cycles to mull over all this, because no matter how hard you are working to make money and save money, if you don’t invest money properly today you are taking high risks. Putting money at the bank means that bank owes you money, and getting in debt means that you owe money to the bank.
I am not a financial expert but no expert can predict the future of finance, else the world wouldn’t be there. Please don’t take my advices for granted I might be well totally wrong. But it is certainly worth defining your own opinion and financial strategy based on facts, not based on what others say. Those who have been called finance expert didn’t predict the major crisis we are now facing for 3 years. Bother to listen to one advice only if you have a proof that one is applying the advice to himself.