I have many reservations and am very critical of the financial system. But the concept of interest on loans is not a "scam'.

The interest in it's simplest form is just a value appreciation of the time value of money [1]. Would you rather have $100 today, or $100 next month? How about $100 today vs $102 next month? Still rather in the today camp? How about $105 next month? That is the interest. It is the value derivative of having the money 'now' vs having the money 'later'.

Where things can get scammy is in the complex type of credit products on offer (tying in all sorts of opaque references to things presented as neutral which are far from), and how things are communicated to the borrower.

Tip: If you are considering a loan, always ask for a full repayment plan showing you which payments are due each month, and the resulting reduction in the amount due (your payment first covers the interest accrued in that month, and only after that covers principal reduction). If there are variables in the loans formula, ask for simulations that cover the most likely evolution scenario, as well as the extremes. Every financial institution has such a payment plan calculator. Long ago I have written one which afaik is still in use today in a non-trivial financial services company.

[1] https://www.investopedia.com/terms/t/timevalueofmoney.asp

Good comment. I sometimes describe borrowing as renting money, where interest is the rent. Its a mathematically interesting construct because, for one thing, the value of the thing you rented goes down with cumulative rent paid. It's kind of a degenerate money cycle if you loan money to someone who uses it to pay you interest on the loan. I suppose only taxes (serving as friction, removing energy) prevent this from being a kind of economic perpetual motion machine! I'd be stunned if this trick wasn't a) very old, and b) have about 1000 modern variations.

I didn't say interest on a loan was a scam I think compound interest on mortgages is. A fixed price interest would make sense like you borrow £100 , you pay back £110. 10% interest. But my understanding on a compound interest mortgage is the bank says something like 2% interest. and they take the £100 and x by 1.02 and just spam ='s on the calculator until the actual interest percentage is like 180%.

You shouldn't have to spend an hour learning how the bank are gnna screw you.

While I appreciate your concern, the problem with what you call 'actual' interest percentage is not what reflects the financial transaction.

As stated above, money has a 'time value'. Getting $100 today has a different value to you than getting $100 somewhere in the future. So to know whether a deal is interesting, I do not just have to know how much I will be getting back in return for my investment, but when. Getting back $180 as a single lump sum payment in a year is different than getting 12 monthly payments of $15 each month for the next year, even though in both cases you will have payed me back $180 looking back.

The interest rate the bank quotes, in your example 2%, is the percentage amount by which your outstanding IOU to them will be increased at the end of the month, before you make your monthly payment.

Now this was an example of a simple fixed interest rate. In practice there are unlimited kinds of formulas that can have variable interest rates over time tied too other things, capped or uncapped, and even then that is just one of the things that goes into a payments plan. So unless you have nailed down all the other factors, comparing just interest percentage A with interest percentage B, typically in the final haggle, tells you little.

This is why I advice always looking at the series of monthly payments that you will have to make over the duration of the loan repayment, and compare these with the series of monthly payments due under a competing proposal.

Banks will screw you over in more ways than you can imagine, but quoting a compound interest rate as opposed to a total amount repaid at the end of contract (which btw is often much longer than the repayment period or even unlimited in time but that is another story) isn't where it is at.

The point that you don't pay the total back at the end resonated with me. I agree holding the money has time value

The thing about loans is that they should also be cheaper if you pay them off sooner. I could believe that they should be simple interest instead of compound, but that’ll get to 200% in only a bit longer (50 periods of 2% interest instead of 35), and banks would want higher interest rates on simple interest anyway, making it equal out. Plus, there are many great loan calculators online to use too.

That's what the 'A' in APR means. It's pretty clear.

If I take out a £100000 loan with an APR of 2% and pay it back in full at the end of the first year, then the total amount I pay back is £102000. Apart from any early repayment charges, the original total term is irrelevant.

When taking out such a large sum, over such a duration for buying your home, the total amount to repay is not the important aspect. It's not like taking out a loan to buy a car or a holiday. You don't have the option of choosing between buying now with a loan, or saving up for a few more months or years to buy without one.

Affordability of the regular repayments over the duration of the loan is the key thing.

There is absolutely no way I would take out a loan of that size with fixed interest in the way you describe. It would be far too expensive, and give the bank too much power.

I'm relying on the fact that I can make large overpayments in order to own my home outright halfway through the original term. That couldn't happen without an annual interest rate. In fact, the most logical thing to do in that situation is to stretch the loan out for as long as possible, so that inflation makes your repayments cheaper.

For a rough example -

Imagine you bought a house for £100K 5 years ago, the interest is such that over 20 years it will cost £150K total (e.g. 3.5% over 25 years).

You have probably paid about 30K, taking about £15K off the capital.

You sell the house for the same amount you bought it. With annual interest, you owe the bank £85K, you give them that, and use the spare 15K for your next home.

With a fixed price, you still owe the bank £120K. You give them the £100K you got from selling the house, and you somehow have to find £20K to pay them the rest.

That last bit made sense to me. I still think it's expensive and the banks have too much power. But you make a good point

This is a good example why one should understand compound interest. Through in a payment schedule and amortization as well.

The bank is giving you $X to buy the house. You’re paying off a piece of it each month (your mortgage payment). Part of that goes to the interest on the loan, the rest goes to principal. The interest each month is based upon on the remaining principal. That means your payment starts off being mostly interest and gradually becomes mostly paying off principal.

You could say, “But I can just save the full price and then buy the house with no interest!”. Sure you could. But you’re forgetting that you’re living in the house (or renting it out...) while you’re paying it off.

"Part of that goes to the interest on the loan, the rest goes to principal."

That's only one kind of mortgage though - for a while there were mortgages available in the UK where you only payed the interest on the principal but you also payed into a separate saving scheme with the idea that when the latter matured it would pay off the former.

No idea if these are still available, but for a while in the early 1990s you used to get a very hard sell on them - we had one for a five years or so. In reality they are a terrible idea as you are paying interest on a non-decreasing principal which is a shockingly bad idea and then there is the risk of the saving scheme performance as well.

Edit: Of course you got a hard sell on them as they were clearly a terrible idea from the borrowers perspective but were far more profitable than a normal mortgage for the lender.

These are still around and pushed pretty heavily, but they are primarily for "Buy to Let" mortgages in my research. And offer an astounding TERRIBLE rate on top of the astoundingly terrible concept.

That said, the interest is a great write off for a landlord, especially if they are personally the originator of the loan to their holding company.

> Sure you could. But you’re forgetting that you’re living in the house (or renting it out...) while you’re paying it off.

Not just that, but definitely do the math on the monthly payments.

In my case (in Chicago), my minimum monthly mortgage payment was half the monthly rent I had been paying, for a significantly nicer and larger place. Just had to get past the down-payment hurdle.

I understand it and i conclude it's a complete racket, along with the whole world

Considering also the Time Value of Money, a mortgage is really not that bad at all.

Just seems like a massive scam thats become the norm. You're paying off interest on the first month, as if you've already had the money for 20 years. They take liberties from day one.

Let's break this down with a simple example: You get a 30yr mortgage for $100,000 at 5%

If you paid $0 on principal your first year, the interest would be $100,000x0.05=$5000

Make it monthly: $5000/12=$416.67 rounded up to $417

On an amortization schedule, the fixed payment is calculated at $537, with $120 going to principal and $417 going to interest on your first payment. Exactly what you would expect to pay. The interest isn't front loaded, it's just the actual accrued interest of what you have borrowed.

When you pay the $120 in principal on your first payment, your debt reduces to $99,880. $99,880x0.05/12=$416 rounded. Therefore, your next payment, still at the fixed rate of $537 is now paying $121 in principal, and $416 in interest.

In short, when you have a large debt, you pay larger interest, when you have a smaller debt, you pay smaller interest. This isn't exploitation, just mathematics.

I conclude that they should just work out the total repayable and be honest and say this is a 70% mortgage. not claim it's 2% but just keep re applying that 2% every month or week or day as they see fit.

Most of the time, the total interest paid is included in the amortization plan. It's also easy to figure out. Using my example, the exact payment was $536.82.

$536.82x12x30=$193,255.20 Total($193,255.20)-Principal($100,000)=TotalInterest($93,255.20) give or take a dollar.

And so according to your desire, you'd want them to say it is a 93% mortgage.

The reason they don't is that interest rates and compounding are typically done annually. You also have the ability to make extra payments sometimes, which can pay it down faster. The faster you pay the debt, the less interest you pay.

For instance, if you win the lotto, receive a life insurance payout, or inheritance, etc and pay off the loan within the first year, it's no longer a 93% mortgage but a 5% one.

To me, it makes more sense to say, you owe $100,000 your first year, or $98,398 your second year, and that you'll be paying 5% interest over that year.

reading some of the replies , I understand a bit better.

Hey, kudos to you for admitting this! I mean that seriously. There are very few folks who actually try to learn and understand things: it appears that you're one of them.

> work out the total repayable

But that depends entirely upon how long you take to repay it. If you pay the loan aggressively up front, you pay less; if you make minimum payments for as long as possible, you pay more.

Lets break this down , 537 per month , 360 months = 193320. Thats 93% not 5%.

It’s 5% per year because you are charged interest on some schedule based on how much you have paid off. 5% is a rate, 93% is a total amount and it only applies if you pay the whole mortgage off at exactly the prescribed rate. Many banks’ mortgage calculators will show you the total amount paid anyway so it’s not like they’re hiding it.

Your point seems to be basically that because you can’t do the maths, the mortgage is misleading. That is maybe a fair argument in some cases with financial products. Investment banks are notorious for obscuring the true cost of deals with complicated maths. However this doesn’t seem like a case of that. If the interest rate is 5% APR and you are free to pay it off as fast or as slowly as you like within some bounds, for example, it is absolutely essential that you understand what a 5% rate means to know how the mortgage works.

edit: not to mention that 5% is already a contrived figure not representative of how the interest is actually applied, designed to make it easier for you to understand what you’re charged. Your interest is probably calculated monthly or daily, not yearly. They could present you a nice hypothetical yearly figure, or a nice just-as-hypothetical 93% three-year figure. What’s the difference? Neither of them are real. Your interest is charged monthly, so they’re equally fake and misleading.

Just as well, you get to start acting like you own the house from day 1.

That is wonderful phrasing on the idea. Thank you.

Why should there be no charge for borrrowing the money for 20 years? That doesn’t make sense, you have had the money for 1 month when you make the first payment, and so you are charged for it.

You do already have the money for 20 years - that’s what the lender “pays” for you on day one.

I don't understand this. You have negotiated to pay a fixed payment per month so why does it matter whether the money is paying off interest or the principal first? The bank didn't force you to get the loan.

It matters to the bank. Also, the interest can be written off against income taxes, which helps people more in practical money left over to use when they are earlier in the amortization, and probably their career.

Bank didn't force me. Society has made it virtually impossible for me to own a property without one. Which seems unfair when a lot of people got their property 35 years before I was born for the equivelant of 2 years salary.

That’s clearly a completely separate issue to how mortgage rates are presented

If you lend me $X at 3.5%/yr for 30 years and I can earn 7%/yr elsewhere, like by investing in a S&P index tracker. Say there's no minimum payment on your loan, just to keep the math easy. In 30 years, I'm going to owe you 2.8 * X (via 1.035^30). My investment of that $X loan has grown into 7.6 * X (via 1.07^30). After tax, call it 6.5 * X. After I pay you off, I've earned about 3.7 * X.

If the initial loan was $400k on a $500k house, then yeah it sucks that I've payed you $1.1M, a clear overpayment, but I wont be sad because I'm coming out ahead by about $1.5M.

In reality, loans come with minimum payments, so you can't come out quite so far ahead. What this all means is if you can do something better with your money, (e.g. market tracker at 7% on a 3.5% loan), then just pay the minimum and do that better thing with the rest. If you can't (e.g. market tracker at 7% on an 8% loan), then pay it down as fast as you can, or don't take it in the first place unless there are other factors.

Depending on your country, the law may require the bank to actually print the total cost of the loan on the contract as well. You'd have a better argument with revolving credits, the rates of which are generally much more predatory.

You need to adjust for inflation.

inflations a big scam too, stop printing bloody money

The printing of US dollars in the last decade had zero effect on inflation.

https://tradingeconomics.com/united-states/inflation-cpi

That is because of how the QE was executed, pouring money directly into the financial markets with negligible impact on the real economy.

In the markets where the money did end up, like the stocks and bonds markets, inflation ran rampant with NASDAQ and S&P history shows.

That isn't inflation. Inflation is about consumables. If the valuation of assets rise, that is actually the opposite: If you sell the asset, the returns can buy you more consumables.

And neither S&P nor NASDAQ had anything resembling rampant gains, BTW:

S&P: https://www.macrotrends.net/2526/sp-500-historical-annual-re...

NASDAQ: https://www.macrotrends.net/1320/nasdaq-historical-chart (you have to click on the "by year" tab).

In neither of these charts a person unaware of QE could identify a trend.

In the last ten years the NASDAQ index went from 2.000 to 8.500 and the S&P500 from 1.000 to over 3.000 in what is generally referred to as the "10 year rally".

Inflation as in the rise in price of a basket of goods is generally used in reference to the consumer price index, but can also be used in reference to stocks, and baskets of those such as the indices.

And before S&P went from 400 to 7000 largely uninterrupted, and NASDAQ from 350 to 7100. But as those are compounding values (i.e. there is not a linear realationship between year n and year n+1, but an exponential one) one can gain more insights from comparisons of the annual returns - that is the reason why I linked those. The annual returns are not unusual, though. Please have a look at them!

If the prices of assets rise, that is appreciation. If stocks or houses appreciate, you can sell them and profit: Your purchasing power rises. If consumables experience inflation, you can not sell them for a profit: They are either immaterial, like services, or can rot, like food. This isn't pedantry, these are different concepts.

At the end of the day, if consumable prices are the same despite having more pieces of paper to buy them, you did not get inflation.

But what about wealth distribution?

Or maybe real inflation is more like 7% where USD should have been deflating by 4% if left alone. QE is just taxes with an extra step.

How do you discourage hoarding and encourage spending and investment, thus keeping your economy flowing, without inflation?