How to Calculate the Interest on an Old Loan to Friend? There Are Several Ways
Q: I have a problem that can’t seem to be answered by any financial institution I have contacted. Sixteen years ago I lent $1,000 to a friend with the understanding that she would repay the principal as well as the interest that would have accrued. I lent the money from a savings account in a large credit union.
The friend is now in a position to repay me, but now the credit union claims they cannot tell me how much interest would have been earned. I even called an out-of-state credit union where I have an account, and they gave me the same blank response. Surely, there must be tables, but I don’t know where else to look. Can you direct me to a source?
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A: We can’t expect too much institutional memory these days. Remember, while your money was on loan there was a thrift and banking crisis that eradicated many thrifts, forced consolidations and started the ongoing merger movement we are experiencing today.
There is, however, a reasonable alternative if you and your borrower can be flexible in making the calculation.
The most widely known authority on asset returns is the Ibbotson Associates yearbook, “Stocks, Bonds, Bills, and Inflation.” In it you will find tables showing returns for individual years and compound returns for any combination of years. The return on Treasury bills from 1982 through 1997 was a compound rate of 6.9%. Your friend would owe you $2,908 if interest was compounded annually: $1,000 of original debt plus $1,908 in interest.
You could make a more exacting calculation by going to the Web site maintained by the St. Louis Federal Reserve Bank (https://www.stls.frb.org/fred/data/irates.html). Retrieve its monthly listing of interest rates for one-month, three-month and six-month certificates of deposit. Be prepared to do a lot of calculating.
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Q: I have a question concerning whether to get a 15- or 30-year mortgage. If I were interested in building wealth and I had a mortgage at 6.875% for 30 years, would I be better off investing the difference between a 15-year and 30-year mortgage in an investment vehicle that will have a greater return than 6.875% and continue paying my mortgage out over 30 years?
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A: A recent analysis by a financial planning association came out in favor of a 30-year mortgage over a 15-year mortgage, based on the assumption that you would earn more on your outside investments. I think the basic idea is correct. If you invest the monthly difference between a 15- and 30-year mortgage in equity mutual funds, you’ll maximize the chances that you’ll receive a 10% or greater return on the equities, and that return will be larger than the interest cost of your mortgage, before or after the tax benefits of interest deductions.
However, this means taking on more risk. And it isn’t safe to generalize from this situation--this is a matter of personal circumstances as much as investment calculation. Here are a few examples of different circumstances:
* Young people should take a 30-year mortgage over a 15-year, particularly if having a 30-year mortgage will increase the amount they can commit to a 401(k) plan with an employer match. If your employer matches on the first 6% of income, having a lower mortgage payment can be a way to increase your income and savings rate.
* The exception to that is young people who expect to move: For them, a 15-year mortgage is a kind of insurance policy against the transaction costs of moving and the chances of having to sell in a down market.
* People with lower incomes and tax brackets should consider the 15-year over the 30-year because their outside investment return hurdle is higher and their tax benefits are smaller.
* People in late middle age with higher incomes should consider accelerated mortgage payments as a de facto bond fund investment. At the same time they should maximize their 401(k) contributions in equity funds.
* Pre-retirees should accelerate their mortgage payments in an attempt to eliminate the mortgage before retirement. Many will find their Social Security income becomes taxable if they have to make mortgage payments with withdrawals from an IRA rollover.
* Retirees who don’t want to risk much money in the stock market often benefit from mortgage payoff/prepayment because the mortgage interest rate is higher than anything they can earn on fixed-income investments. In addition, there are cash-flow benefits because mortgage payments include principal as well as interest. Paying off an old mortgage can make retirement income a lot easier to handle.
Basically, the shorter your time frame--whether it is job mobility or looming retirement--the greater the benefit of accelerated debt reduction.
Many personal finance decisions are being distorted by today’s extraordinary returns on common stocks. Viewed in perspective against historical returns, paying down a 7% or 8% mortgage is a slam-dunk investment.
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Scott Burns writes for the Dallas Morning News. He can be reached at scott@scottburns.com, or at his Web page at https://www.scottburns.com.
If you have a financial question of general interest, write to Money Talk, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053, or e-mail business@latimes.com with “Money Talk” in the subject field.
