6. Suppose you owe $1,000 on a loan and the interest rate you are charged is 20 percent a year, compounded annually. If you didn't pay anything off, at this interest rate, how many years would it take for the amount you owe to double?
- Less than 2 years
- 2 to 4 years
- 5 to 9 years
- More than 10 years
6. Suppose you owe $1,000 on a loan and the interest rate you are charged is 20 percent per year compounded annually. If you didn't pay anything off, at this interest rate, how many years would it take for the amount you owe to double?
Answer: 2 to 4 years.
People who thought it would take five years forgot about interest compounding. After one year you'll owe $1,200. After two years the 20 percent gets applied to that amount, which means you'll owe $1,450. And so on...
If that sounds complicated, here's an easy rule of thumb. Just apply the "Rule of 72" to any interest rate or rate of return: Divide 72 by the rate of return and the result is how long it should take your savings to double -- or, in this case, your debt to double.
So if you get a 10 percent return, it will take 7.2 years for the amount to double. Getting a 6 percent return will require 12 years. Getting a 4 percent return will take 18 years.
Which means it will take 3.6 years, if you don't make any payments, for the $1,000 you borrowed to double.
And if that sounds a little loan shark-y, it is.
Actionable Items
72 rules - review (1 + 0.01)^72 = 2
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