Increase Finance Productivity and Lower Home Prices
Finance plays a crucial role in the economy by facilitating money transfers for investment rather than consumption. It enables profits generated in one business to transfer to other ventures.
This article explains why finance is currently economically inefficient and outlines how to make it the world’s most efficient industry. Economic efficiency is the least amount of money needed to create an investment. An investment will generate goods and services while leaving its value the same. Over time, an investment may generate more money than its value but will not generate value if unused. For example, banks enable investments by lending government money to individuals and organisations, and the service is paid by borrowers paying interest. The interest covers a bank’s operational costs plus a profit to cover the capital investment and regulated requirements. For example, the bank has to have reserves of liquid securities that the bank can sell to cover withdrawals. However, the same reserves can be used repeatedly for consecutive loans. The bank claims these extra profits while doing nothing more to earn them.
Interest Bearing Loans or Debt
Debt, a common financial tool, is a common means of transferring investment money from one project to another. It involves lending money with the expectation of receiving more in return. The longer the wait, the higher the interest return.
Typically, debt repayments are periodic payments. With compound interest, the lender removes the interest but does not deduct any interest from the balance owed. Instead, the lender treats the interest as part of the loan and charges interest on the interest.
A reasonable person would think it immoral, if not illegal, for a bank to charge for something unnecessarily. It is public money, with both lender and borrower benefiting and responsible for repaying it. The lender gets an extra benefit that the borrower pays for. The issue can be easily resolved by shifting simple interest and compensating the Bank with a slightly higher interest rate.
Compound interest by banks is an inefficient way to transfer investment money as it costs the borrower much more than necessary. It is solved with the accounting change to simple interest. To reiterate. Compound interest means interest is paid twice, and interest is paid on interest.
We can remove this double payment using simple interest instead of compound interest.
The Savings from Simple Interest
The savings to the community of using simple interest are very large, and the change is easy to accomplish and could be guaranteed for banks as they are regulated.
Savings by using simple interest
In the above graph, the blue bar represents the savings from changing from compound interest to simple interest. The blue bar represents the yearly savings on a $100,000 loan for different periods, and the red bar represents the savings by varying the interest rate. Two added together represent the total savings.
On the graph, the yearly savings on a forty-year loan at 10% is $17,180 per year for 40 years. Compound interest means the borrower pays about $800,000 to receive $100,000. With a simple interest loan, the borrower pays $200,000 to receive $100,000.
For a 6% home loan of $500,000 over 20 years, repayments change from $43,592 to $25,000 a year. The savings can be shared between the lender and the borrower, leaving both parties better off.
This is a Real Savings
All mortgage holders should be very angry with the financial institutions and governments. There is no excuse for governments to allow Banks (who are regulated) to use compound interest. Changing to Simple Interest or existing houses dramatically reduces costs without reducing prices. It frees up immense amounts of Capital held in unnecessary Bank Reserves, Bank Share prices and inflated house prices.
Removing the Remaining Interest Cost
The cost can be further reduced when transferring existing assets. One way to achieve this is through Permanent Home Markets, where a home valued at $500,000 can be partially purchased and lived in for $371,845 instead of the current cost of $43,592 multiplied by 20, which equals $871,845. In a Permanent Home Market, the cost of living in a home is the property's rental income. In the example, at the end of twenty years, the occupier does not completely own the house - only the shares they have purchased. For investors, their investment yields the same return without the associated costs of owning the house.