I keep telling people – the problem with borrowing is NOT the loan, it is the interest. And the inflation that we cause by borrowing, and repaying – we are creating money, are we not?
Let us say you borrowed Rs. 20,000 to buy a house and it is a 30 year loan. Clearly you would have repaid 72,000 + processing fees+risk premium on your life, on the property…etc. Which means you have paid about 52000 as interest for a Rs. 20,000 loan. Great.
Did the bank ‘give’ you this money by pulling out 20k from its vault? Hey no. They just pressed a few buttons. Sure they had to process the application, keep records, etc. BUT they did not produce ANYTHING to claim such a huge compensation. And I am not even talking of the fact that the bank would have earned much much more because this 52k came on a monthly basis and it was being used during the 30 year period.
What did this extra 520k do for the economy? Nothing really. It went to pay some interest to somebody in the bank, salaries, rent, mistakes of the bank, etc. – LARGELY IT CONTRIBUTED TO INFLATION because it was money for which NOTHING else was done!
This combination of ‘repaying’ what was not there and the ‘interest’ on something which did not exist goes and crates an unending supply of money. Unending supply does the worst thing that it can do – fuels inflation.
There is another bad effect of interest – it slows down the speed at which money gets circulated. For example if you borrowed Rs. 20,000 and repaid Rs. 200 per month you should have finished the repayment in 8 years. However because you paid an extra 520k you are paying this over a 360 month period!! So interest slows down the money circulation – thus increasing the need for money. So more money has to be printed. Eeks this mean more inflation, right?
Inflation also encourages HOARDING. If I can postpone my payments I will – because my rupee of tomorrow is worth less than rupee of today. Funnily interest payments encourage hoarding, and delaying of payments. This might lead to a higher NOMINAL payment but a lesser REAL payment. Oops. Tough to understand is it?
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