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Longer loans worse than shorter ones

March 13, 2018

Are longer loans worse than shorter ones? They certainly are. People don’t think about the compounding of interest or the erosion of the asset they are funding over a term exceeding its lifetime.

Let’s think about a house – you buy it for $300,000 but over a 25-year amortization you actually pay $450,000 – an additional $150,000 for interest. If you refinance over a longer term by adding another five years to the mortgage term the interest goes up exponentially.

It is not unusual to see people pay $6 or $700,000 for a house that was only worth $300,000 to begin with. Similarly, we see people getting into long term debt with car loans – now up to 9-years of repayments. The vehicle was typically overpriced by a dealer markup of up to 35% of the actual dealer cost at the time of purchase so you may have paid $45,000 for a vehicle the dealer only paid $30,000 for – hence the notion of “depreciating 30% just by driving it off the lot”.

Credit card lending should be better regulated, after all who is going to live for 200-400 years to reach the end of the payment arrangement? Think about interest compounding at between 17-29% annually and required payments either at below the rate of interest accrual or marginally above it.