It might be time to apply for a loan

Today, I won’t talk about coding, while I see this discussion related to programmer’s life. If you read CodeBetter you are certainly a programmer, making and saving money with your coding skills and your energy. I’d like to talk about a few things related to money and especially loan. The point is that getting in debt is essential in life. In this time of crisis, where millions of people got ruined because of their loan, I don’t want to sound ironic. The secret is to get in debt with a fixed interest rate loan. The important word is fixed. Why? Because of inflation!

A word on Inflation

Inflation is the measure of the fact that the price of everything increase over time. Something that costs 2 bucks today, used to cost 1 buck a few years ago and will cost 3 bucks in a few years, we all know that. If you talk with your dad and ask the amount of salary he got, you might be surprise to hear it was a just a fraction of your salary today.

For example, your dad as an engineer was paid 25.000 US$ a year 20 years ago while you get pay 70.000 US$ today. 20 years ago, to purchase your dream’s house, a loan worth 8.000US$ a year over 20 years was enough. But today the same loan for the same house could cost well 30.000US$ a year. The amazing thing with fixed rate, is that, if today you were about to pay the last annual fee for your 20 years fixed rate loan contracted in 1991, it would cost only 8.000US$. If it was a variable rate loan, you could be well paying much more instead! So with a fixed rate loan, the higher the inflation is, the more you win. Getting in a long term fixed rate loan is the way to see inflation as something positive.

So what can we say about the near future of inflation? Nowadays, both US and Europe states got into an insane debt level. The US debt alone is worth 15.000 Billions US$ while something as ground-breaking and successful as Microsoft, Google or Apple ranges in the 100 Billions US$. The following famous picture represents the US debt stacked in 100US$ bills:

There is absolutely no way these debts will be honored properly. What could happen is debt canceling, which could provoke a war with say, China that owns a large portion of the debt. More preferably and more realistically, what will happen is that government will provoke more inflation. Nobody likes inflation, because it ruins people, corporations and economy. Remember? the only winners in case of inflation are those who have a lot of debts.

Actually during the last 25 years inflation has been kept low artificially, because states changed their strategy and borrowed to tiers actors like banks and other states, instead of borrowing to themselves. Indeed, before that period states used to borrow to themselves by provoking inflation. The result of this new strategy is the insane debts. More inflation is something governments know how to start, by printing more money, but don’t know how to stop. Hence they are still reluctant to go back again with inflation, but inflation is the only chance to give the global debt less value, and maybe get the head out of this situation one day.

If you look at historical US inflation, you’ll see low 3% to 5% rate since 1985, while it used to be up to 13,58% in 1980 and even more after the two world wars. I produce this US inflation graph from 1914 to 2010, from data available here, : http://inflationdata.com/Inflation/Inflation_Rate/HistoricalInflation.aspx

If you contract say, a 4% interest rate loan today, each future annual inflation rate above 4% will make you richer. And as said, there are serious reasons to think that inflation rate will grow insanely soon. Inflation rate above 10% has been reached not so long ago, this is clearly part of the possible.

Visualizing Compound Interests

Recently, me and my relatives had the chance to contract a few fixed rate loans, and I got pretty interested into the math beyond it. It is actually pretty basic math, but still, Einstein called compound interest:  the greatest mathematical discovery of all time. To my disappointment, I found zero compelling offers on the web to quickly play with loan parameters (amount/term/rate) and get an immediate visualization of the impact on the loan cost. Weird but true: There is no good offer to visualize properly what is certainly the most important financial decision anyone has to take?!

This is why with a friend working in the financial area we created the free site http://www.loanfor.us/ in English and http://www.simulcredit.fr/ in French. At a glance, you can see that if you get a 20 years long loan for 300K US$, the loan amortization will look like that with a 4% annual interest rate:

And like that with a 8% annual interest rate:

And like that with a 12% annual interest rate:

The orange area represents the cost of the interest of the credit, while the green area represents the 300K borrowed. With an interactive calculator it is clear that the interest cost are not 4%, 8% nor 12% of 300K, which are 12K, 24K and 36K. The interest cost are 154K, 320K and 511K or 52%, 107% and 170% of the amount borrowed!

Imagine to give away 511K to have the chance to reimburse 300K!!! My dad said that 30 years ago, it was not exceptional that the interest cost could grow up to 200% of the amount borrowed. Of course, in these conditions assets like real estate prices are decreasing. On the other side, nowadays nobody is trusting finance and economy anymore, and with gold, real estate remains a compelling investment, which makes real estate price increasing. With these two opposite trending playing against each other, today nobody can predict how assets or gold prices will evolve.

Another interesting graph is the monthly repayments vs. the loan term vs. total credit cost, below in yellow.

There is a balance here, between short term high monthly repayments and long term high total credit cost, choose one. Because of the potential future high inflation, my bet is that long term like 15 to 25 years are preferable. It is also preferable because this way you can borrow more and purchase more and bigger assets today.

So what?

Thanks for following my reasoning; it is now time to go back to cool coding activity. But make sure to free up some brain cycles to mull over all this, because no matter how hard you are working to make money and save money, if you don’t invest money properly today you are taking high risks. Putting money at the bank means that bank owes you money, and getting in debt means that you owe money to the bank.

I am not a financial expert but no expert can predict the future of finance, else the world wouldn’t be there. Please don’t take my advices for granted I might be well totally wrong. But it is certainly worth defining your own opinion and financial strategy based on facts, not based on what others say. Those who have been called finance expert didn’t predict the major crisis we are now facing for 3 years. Bother to listen to one advice only if you have a proof that one is applying the advice to himself.

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  • Anonymous

    But they won’t. For two reasons: 1. They have dual mandate, low inflation and low unemployment. When the two becomes perceived as opposites, which one will win? 2. Political pressure will ensure that low unemployment becomes the preferential target for the Fed, making high interest rates unattractive even when facing growing price inflation.

    We’ve been through this before and it won’t be pretty this time either.

  • Anonymous

    Don’t forget that the ultimate winners are the politicians. That’s why we even have inflation.

  • Anonymous

    hey

    vaut mieux pas mettre ca
    1) ca fait un peu trop pub la dernière remarques
    2) un blog post a trés trés peu d’activité et d’impact une fois écris, ca je l’ai bien expérimenté

    ca qui serait vraiment chouette ca serait de contacter des bloggers comme ceux là, il doit y en avoir des tonnes comme en .NET http://www.mint.com/blog/how-to/understanding-financial-statements/ http://financialanalystblog.com/

    en t’introduisant, gars de la banque de france, tu présente le site rapido et tu explique que le référencer de chez eu ca t’aide au niveau SEO,mais c bien pour le bloggeur de référencer un outil gratuit de qualité d’expérience miuex vaut se faire la main sur des petits bloggeur avant d’attaquer des gros
    qu’en penses tu?

    bonne année :)

  • Serge Girard

    As far as the euro zone is concerned, datas just released by the ECB (M3 monetary aggregate, basically the total amount of money available in an economy at a specific time) let augur more of a deflation for 2012 than heavy inflation.

    Take a look at this short article :
    http://www.telegraph.co.uk/finance/financialcrisis/8983067/Eurozone-credit-crunch-fears-on-M3-money-contraction.html

    And I have extracted this chart from the ECB website’s figures :

    (BTW, I had never seen before such a clever loan simulator as http://www.loanfor.us )

  • Patrick Smacchia

    Glad we agree Ben, I don’t try to convince people, but it’d be good people think, especially developers that are used to think about more interesting things than money :)  

    The current crisis will provoke something very wrong, some changes in our US/Europe way of living, because the states’ debts cannot be reimbursed, this is mathematic, whatever the FED (US) or BCE  (EU) forecast. Somehow we have to pay the bill of 25 years of living above our means with a low inflation.

    Certainly even mutual funds will be seriously impacted, as any financial assets, hence I’d say invest in concrete assets.

    I consider it as a (last?) chance that long term fixed rate are still low in these conditions, and this is the point of the current blog post. This is my opinion, I can be wrong but I cannot imagine any way I could be wrong.

  • Ben

    I realized that when writing the last comment.  I wasn’t addressing the fixed vs. variable argument.  We agree on fixed vs variable.  Sub-prime was just an example of a symptom of speculation on the housing market, which hurt more than just the sub-prime and their contractors.  And actually, because we both disagree with variable rate loans, it’s speaking to my point  – that we get stupid when we speculate on things going up or down, taking on more risk than it appears, even for those not taking out sub-prime.  Many people ended up upside down on their mortgages because of the quick decrease in home values.  And I agree with you, that the financial systems involved are to be blamed.  I don’t trust them because they speculated on this market big-time and used all sorts of financial products and packages that, once upon a time, were not allowed (recent deregulation done by both sides of the isle opened up some of the causes to our issues).  That does not make all financial institutes bad, much like a few jerks on a sports team makes the sport itself bad.  Mutual funds are powerful, conservative, steady winning products where it’s really really hard to lose money.

    On the numbers, I agree with you as I said.  I’m just sharing my opinion through this specific context.  I hope you don’t mind.  I don’t intend to offend, but I hope I can bring about the other side of the coin that the world is starting to see a bit more these days…Including myself…that the game of debt isn’t so fun.  Maybe we should be more careful with it.  Maybe…just maybe…even avoid it when possible, because…

    The borrower is slave to the lender

    That’s not to say borrowing is evil or wrong.  It just calls it what it is, something we probably should avoid.

  • Patrick Smacchia

    >So I’ll get me a sub-primeSub-prime were not fixed rate, it came with complex variable rate pretty impossible to forecast. Else most sub-prime contractors would have been able to continue paying their constant monthly repayment. The current blog post sense is all about ***fixed*** rate, and underlying math reasoning. One replaces the word ***fixed*** with ***variable*** and one got ruined.

  • Anonymous

    This is really true for Country like India. We have been experiencing inflation consistently over 10% for past few years. The loan rate in India is roughly 11% and Fixed is almost 14%!!

    So best strategy as far as Indians are concerned is to not think about any kind of loans!

  • http://twitter.com/thefringeninja João P. Bragança

    The Yuan has actually *appreciated* against the Dollar since the financial crisis. So my imported television should cost more.

    The world is currently experiencing debt-deflation – people realized they’ve amassed to much debt, and therefore demand cash to straighten out their balance sheets; the fed supplies it to them. Look for Michael Pettis’ blog, he does a way better job of explaining this than I ever could.

  • http://twitter.com/thefringeninja João P. Bragança

    So what? That was done in response to the velocity of money slowing down – i.e. deflation. M0 has exploded – and yet M3 has *imploded.* If / when inflation starts to happen the fed can simply raise interest rates to squash it.

  • Ben

    I think those who save and invest in diversified mutual funds (not single stocks which is like gambling, as you mentioned a single companies down turn) earn over the long run consistently.  Yet those that use debt to gamble on the market timing like your policeman guy, that’s high risk and falls into the same pattern as ponzi schemes which tend to crash (If not on one person, than another.)

    Good Mutual funds are diverse stock profiles and have been able to recover after each recession pretty quickly.  More so than the news shows since they focus on single bad days or single companies.

    But asset speculation is what got us into the economic recession we’re in.  You know that right?  People around me kept saying, buy as much house as you can because they’re only going up in value.  Shoot, with that logic, even a ARM variable interest rate makes sense, right?  It’ll be worth so much more in a few years.  So I’ll get me a sub-prime and get me the most house that rate can afford.

  • Patrick Smacchia

    The only thing one can predict is:
    A) US and Europe debts won’t be reimbursed properly, this is mathematically not possible, I don’t believe in finance but I do believe in math.
    B) As a consequence of A) the debt problem will provoke bigger problems, it can be war or inflation or another form of problem. But sadly it won’t be bright :o/

    Taking account such a state in-debt problem, this situation doesn’t leave all options open.

  • Patrick Smacchia

    >Lets take the same $1893 per month and invest it in a good diversified mutual fund plan at 8%
    Do you still believe in finance? I don’t, what if you’ve invested this money in a bright Lehman Brothers plan, or in a shiny Bernard Madoff transaction?

    >There are people and businesses that manage to do very well

    Sure, making more money from your own business is always the best solution, bust applicable for just a few lucky.
    But there are also plenty of old people with plenty of assets that didn’t wait to be old to acquire their assets. They borrowed early in their life to benefit from the assets income early to buy more assets and so on. I know an old retired policeman that is wealthier than an old retired doctor, just because the first was smart enough to contract debts and acquire assets at the right time.

  • Dylan Smith

    You say what will happen is not predictable, but you just predicted that we are in for some major inflation in the near future.  These statements are at odds with each other.  Which is at, nobody can predict what will happen with inflation; or inflation is going up high and soon?

  • Patrick Smacchia

    I am sorry for what happened to Argentina. As you wrote speculators win. Buying assets now by forecasting that there will be inflation is a form of speculation. 

  • Patrick Smacchia

    I live in Europe, France, and here real estate prices are still pretty high, I don’t imagine them dropping anytime soon, but I might be totally wrong.
    Certainly manufactured goods are cheaper mostly because producer countries like China maintain an artificially low exchange rate for their currencies.

  • Ben

    I get the whole math thing.  Variable loan rates put market-risk on the consumer.  Fix-rate, on the banks.  I rather have the banks take the risk…if I was to get a loan.

    What about not borrowing?
    If you don’t borrow money, you pay zero percent interest.  That’s a good rate.  And it’s the same every time, last I did the math. 

    And what about the opportunity cost????
    For example:  Lets take the same $1893 per month and invest it in a good diversified mutual fund plan at 8% (which is a reasonable average over 10 or 20 year period, BTW).  In 30 years, you’d have $2,840,058!  And $2,158,578 of that was interested received! 

    I realize, in some cases there are things as to why you’re getting a loan that offset the opportunity.  For example, if you didn’t get a mortgage on your home, you’d need to rent.  But let’s play with that too, to be fair.  How about a $1300 monthly rent payment with utilities being constant compared to the house?  That’s still $392 you could invest each month.  Compounded over 30 years at 8% is $889,675.12.  Just food for thought.

    But my concern is the assumption that “debt is essential in life”.  I
    believe that is what the culture thinks is true, but it isn’t.  There are people and businesses
    that manage to do very well (if not better) in life…without any debt.

    Debt is not essential, it’s dumb.

  • Joe Kelly

    They are simply lagging due to week markets. Glancing at the H3 report from the federal reserve shows the monetary base has more than tripled since 2007.  Normally this would be controlled by raising interest rates to very high levels to suck back some of that money from circulation.  The problem is our national debt provides a stronger argument for printing yet more money to devalue our currency causing excessive inflation.  The ultimate double whammy.

  • Lucasontivero

    Nobody wins with inflation (only some speculators). I am from Argentina one of the countries  with the worst history and painful experiences with this problem and you can be sure that in the race between salary and prices, prices always win (you lose)

  • http://twitter.com/thefringeninja João P. Bragança

    What prices are going up? Food and energy. Prices on *everything else* are going down (e.g. housing, electronic goods, etc).

  • Patrick Smacchia

    deflationary environment? Do you see prices go down and get more for your money than you used to have? me no

  • Patrick Smacchia

    >Market is not betting on inflation, is it ?
    Did market bet on subprime crisis back in 2008? Market is not more an expert than me and you, what will happen is simply not predictable.

    >Following your reasoning might be very dangerous

    100% agree, but not following it might be very dangerous too, what if all your savings melt because of inflation?

  • http://twitter.com/thefringeninja João P. Bragança

    This is all well and good in an inflationary environment. It is LETHAL in a deflationary environment such as the one we’re in right now.

  • olivier raoul

    Loanfor.us is a great tool indeed but I don’t totally agree on the global reasoning: the best indicator of the anticipation of the future inflation are the long term rates and today the long term rates are quite low. Market is not betting on inflation, is it ?
    Following your reasoning might be very dangerous in case of a global recession (loss of jobs, and deflation).

  • Patrick Smacchia

    Dylan for 1) I completely agree: You are paying 500k *over 20 years* to get 300k *today*. Thanks for this precision. This implicitly states that inflation does its job of  transforming big value (500K) into lower value.

    for 2)   You can’t count on inflation going up in the near future, that is trying to predict the economy, which is folly for anybody who is not an expert. 
    as said I don’t believe expert advice can help because this is not a science like math or software programming. Very few experts predicted sub-primes and the current crisis. I’d say we can call those who predicted right lucky.

    There is one undoubted fact, an insane level of debt for US and Europe, and looking back at history, high debt usually lead to war or high inflation. Of course the second option would be preferable and I am betting on it.

  • Dylan Smith

    A couple comments:

    1) You have to think about the Net Present Value (NPV) of money.  When you say you are paying 500k to get 300k in money it’s not entirely accurate.  You are paying 500k *over 20 years* to get 300k *today*.  The NPV of 500k over 20 years is significantly less than 500k today.

    2) You can’t count on inflation going up in the near future, that is trying to predict the economy, which is folly for anybody who is not an expert.  If you truly believed that you knew that inflation will increase in the near future, there are financial instruments where you can effectively “bet” on this.  If you were confident this was true, the best thing you could do is not get some loans, but go invest in a financial instrument that will pay off if your prediction comes true.  Doing this though is effectively saying you know more than wall street about what is going to happen to inflation.

  • Patrick Smacchia

    Sure, there is a risk when getting in any sort of debt. What I mean here
    is mostly that not getting in debt represents also a risk, a risk of
    seeing your savings melt like ice on sun, a risk of not being able to
    purchase any assets in the future.

    It is pretty interesting to
    talk with older 50 to 70 years old people. It looks like the level
    of wealth is mostly determined from who got in debt young and bother their
    own assets and heritage, more than who had a higher level of income. The
    reason is that inflation gave a solid advantage to the first ones, but
    this is something not trivial to pinpoint.

  • Guest

    This is great if your income rises faster than inflation (…and you’re not unemployed).  Otherwise, servicing your debt — although at the same rate — is taking MORE of your available income since everything else is more expensive.