The Time Value Of Money Effects Credit Card Debt

The most significant fact to remember about debt is that the longer the borrower has the use of the money borrowed the more valuable it is to her and the less valuable it is to the lender. The following information will help display how the time value of money works. The terms are listed below.

Interest- An amount of money accumulating on a given amount of money over a specified period of time. "Interest" is a fee, paid on the borrowed capital or assets. "Interest" can originate from many sources such as a return on an investment you made, or from a specified interest rate loan you made such as a bank deposit, where the bank is using your money for a period of time.

How much money you have NOW in the present is called Present Value and the future sum of money that a given sum of money is "worth" at a specified time in the future given a interest rate or rate of return is called Future Value.

To give you and example of how this works, suppose your brother or sister owed you $500. Would you rather have this money repaid to you right away, in one payment, or spread out over a year in four installment payments? Would it make a difference either way? Ok you probably answered that you wanted the money right now. And you would be correct becuase according to a concept that economists call the time value of money, you would probably be better off getting your money right away, in one payment. You could invest this money and earn interest on it or you could use this money to pay off all or part of a loan. There are a million things you could do with this money if you had it today. The time value of money refers to the fact that a dollar in hand today is worth more than a dollar (or sometimes more) promised at some future time.

Your probably wondering and asking yourself, how can that be? A dollar is a dollar, isn't it? Yes, but a dollar in hand today can be invested in an interest-bearing account that would grow in value over time. It could also be invested as a initial payment on an asset, which can pay you every month. This explains some of the reason why the value of money is related to time.

The next term to know is Opportunity Cost. Opportunity Cost is the time value of money must also be related with another notion called opportunity cost. The cost of any decision will also include the cost of the best-forgone opportunity. If you pay $100.00 for a football ticket, the cost of your resence at that football game is not just the ticket admission price, but also the time and cost of what ever else you could have been doing instead of the watching the football game. Applying this concept to the $500 owed to you, you see that getting the money in installments will encumber you with opportunity cost. By taking the money over time, you lose the interest on your investment or any other use for the original $500, such as spending it on something you would have liked more. So, what you should know is that the exchange between money at the present and money in the future is dependant on, among other things, the rate of interest you can earn by investing.

What if the $500 owed to you was receiving a compound interest, would that change things? Sure it would. Compound interest is the concept of adding accumulated interest back to the principal, so that interest is earned on interest from that moment in time on. The act of declaring interest to be principal is called compounding (i.e., interest is compounded). For example, the $500 owed to you could have interest that is compounded every month: in this case, a $500 loan at 1% interest per month would have a balance of $505 at the end of the first month. If the $500 loan was for 12 months the 1 % interest would compound on itself and at the end of 12 month the amount owed would amount to $563.41

The practice of leaving the initial investment plus any accumulated interest in a bank for more than one period is reinvesting the interest. This practice is called compounding. Compounding the interest means earning interest on interest so we call the result compound interest. With simple interest, the interest is not reinvested, so interest earned each period is on the original principal only.

How does the time value of money relate to credit card debts? It is important because let's say you have a total monthly payment on all of your credit cards of $800 and a collective balance of $65,000. Now you are spending the $ 800 and losing the time value of that money, and conveying that benefit of that money to your creditor. What could you do with that $800 and what could you do with twelve of those payments ($9,600) in one year? What could you do with the next 20 months of those payments? What if you had $30,000 in cash to use in a settlement on the entire balance? What could you do with that money if instead of paying creditors, you invested it and used the return for something that benefited you financially and improved your situation or position?

Why would anyone want to try and pay creditors from a place that depletes their savings, compels borrowing from family and friends or places them further into debt, especially against their home in the form of home equity? It makes no logical sense. Creditors will never tell you this, but if you have the ability to place yourself into a better financial position and then make payment arrangements with creditors, you will not only serve yourself and your family first, you will be better able to return the money you borrowed and do it in a way that is mutually advantageous to the both of you. Many people after gaining the right perception and understanding of these types of strategies will do this and will realize that you have the final say about whether or not you will pay anything at all to your creditors. This knowledge is a very helpful tool and once you have it in position; you will be free to make this judgment for yourself.

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