The rule of 72 (Part 2)

Now for the bad news.  The same rule that tells how long it’ll take to double your money also tells you when you’ll double your debt.  That’s right; this rule applies not only to the interest rate you RECEIVE, but also to the interest that you PAY. And because most debts, particularly credit cards, charge interest at a much higher rate than you get when you invest, you’ll see your total amount owed double even faster.  Let’s try it out.  The average credit card these days charges 11% interest.  The rule of 72 tells us that at 11%, your debt will double in 6.5 years, WITHOUT ANY ADDITIONAL CHARGES.  And what happens at higher interest rates? Rates as high as 22% are common.  Let’s take a look.

Interest Rate        Years to Double

12%                            6
14%                            5.1
16%                            4.5
18%                            4
20%                           3.6
22%                           3.2

Ouch.  That means that at 22%, that $100 you owe is going to cost you double in just three years.
What can we learn from the rule of 72 in this case?  Well, it certainly puts into perspective what carrying a credit card balance will do to us.  It also shows how high risk can translate into high rewards.  If nothing else, it gives us a barometer to measure the interest rates all around us.  Thinking of carrying a balance on that 18% interest credit card?  Think again.  Deciding if that 4% interest CD is worth it?  Well…depends on what your goal is.  No matter how enlightening a rule is, it doesn’t exist in a vacuum.  It always depends on how you use it.  Hopefully, this particular rule will help us make better financial decisions.

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