An interesting conversation about… Interest

June 23, 2025

There are many definitions of interest, but this one has been my go-to for a long time. Short. Simple. Strong.

in · ter · est

1. the cost of money

The cost of money. Let that sink in. It means that there is a cost associated with money’s existence; not just for borrowing or lending. There is also a cost to holding on to money. You know, the old shoe box, mason jar, or mattress-style storage facility. What’s the cost with the jars or boxes? Opportunity cost – the money can’t earn interest; it can’t work for you.

Our bank accounts are in play here as well. If money is in the bank, we aren’t using it, and that is our cost. We make up for that cost by asking the banks to pay us interest.

But most of the time, we think of the cost of money in the form of paying interest–it’s a real cost and a major factor when we borrow.

However, although interest rates are highly marketed as the starting point for borrowing decisions, they shouldn’t be. The borrowing decisions should always start with how much is being borrowed, why it’s being borrowed, what it’s going to buy, and whether we can afford the entire amount rather than just a monthly payment with “low low LOW” interest.

#1 on the list

Car loans. There is no better example of how debt is marketed through interest rates than the car loan. When I see a $40,000 vehicle sold as “only $550/month for 72 months at our LOW 2.9% APR” it triggers a sort of personal finance trauma, reminding me of when I put myself into the car debt cycle, all the while convincing myself that I got a “deal” based in the interest rate.

A quick analysis based on 2024 data:

Average new car price $48,000
Average interest rate 7%
Average term 68 months
Average down payment + trade-in $12,000
Monthly payment $645
Total interest paid $7,700  (11% of price of car)

Now apply the “limited offer” of 2.9% APR (only the best credit scores get this, by the way):

Monthly payment $574
Total interest paid $3,100 (6% of price of car)

Did interest rate matter? Yes, to the tune of $4,600 over 68 months or about, coincidentally, $68/month.

The bigger personal finance issue here is that the interest was based on a loan of $36,000 (after trade and down payment) for a $48,000 ride.

What’s more likely, that we find ourselves in a pinch because of $68/month in interest or because of a $48,000 purchase (which is losing value by the mile)? And don’t forget all the other costs of a $48,000 car; higher property tax, MUCH higher insurance costs, higher sales tax.

Again, interest rates must be considered, but not as much as the amount borrowed. Transportation is important, cars are the reality for most of us, and prices are staggering. But there are ways to mitigate those costs – the overall cost of a car and its impact on our financial well-being.

The bottom line: minimize borrowing for a car and interest rate will be an afterthought.

Plastic problems

When we find ourselves concerned about the interest rate on our credit card, we have a bigger issue to address – credit card debt period. Pay off the debt and only use cards for budgeted expenses, and the interest rate won’t matter. Furthermore, signing up for a new, lower-interest card to transfer a balance is often a symptom rather than a cure. This is not ‘never do that’ advice, but a caution that these card offers exist because, statistically speaking, most people will end up using the new card and, ultimately, find themselves further in debt instead of improving their financial situation.

The best plans for managing credit card debt include 1) not using the card 2) using a budget with a payoff plan and/or 3) contact a free credit counseling service if the debt is overwhelming your finances.

But what about student loans?

From a numbers and interest rate perspective, I could just copy and paste from the first section on car loans. The math is what it is and, once again, interest rates don’t matter in comparison to the amount borrowed. The big difference here is that an education is not a depreciating asset, so the calculus on how much to spend/borrow includes other (and not always quantifiable) variables.

The bottom line is the same – minimizing borrowing comes before worrying about rates.

There is a lot to consider – FAME is here to help. Check out this link and the resources on the side menu.

Date the rate, marry the home

Similar theme for houses, but the stakes are higher. Yes, it’s easy to see that a 1% rate difference on a 30-year loan could mean $100,000 in interest, but since the rates are determined by credit score and market conditions, it’s largely out of our hands when we sit down to sign the papers. What is not out of our control is how much down payment we’ve saved, how much we borrow, and ultimately, whether we are choosing a home we can truly afford.

This is an excellent tool from Enrich on determining how much home you can afford, considering income, location, down payment, and other debts. Enrich: Home Affordability Analyzer

It took me a while to get here but it was worth the effort

For me, it took many years to reestablish a financial foundation, and one of the key pieces of the puzzle was eliminating non-house debt and paying cash for just about everything – including cars.

So…

• I have no idea what rate my credit card charges because I haven’t paid a dime of interest in a couple of decades. I use it for budgeted expenses and pay in full every month. Emergencies are paid for from my emergency fund. The credit card provides convenience and reduces exposure to theft/fraud compared to a debit card.
• I paid cash for a used car.
• I don’t love the interest rate on my home, but the house is affordable based on our down payment and how the overall mix of mortgage, home value, income, and budget is in my favor. And refinancing at a lower rate is often worthwhile for an appreciating asset like real estate.

Finally, if debts are paid, then the only interest you need to think about is the type you are earning. What’s the cost of your money?