The most important fact to remember about debt is that the longer the borrower has the use of the money borrowed, the more valuable it is to him and the less valuable it is to the lender.
Time Value of Money
The following paragraphs will demonstrate the time value of money.
Interest is, of course, a sum of money accumulating on a given sum of money over a specified period of time. Interest is a fee, paid on borrowed capital or assets. Interest can originate from many different sources, such as a return on an investment, or from a stated interest rate loan you made such as a bank deposit, where the bank is using your money for a period of time.
To make sure that you understand where we’re heading with this, here are a few terms to keep in mind.
Present Value: How much money you have NOW in the present.
Future Value: The future sum of money that a given sum of money worth at a specified time in the future given an interest rate or rate of return.
For example: Suppose your brother or sister owed you $500 for a car repair. Once they got their next paycheck, would you rather they repaid this money to you right away in one payment, or spread out over a year in four installment payments? Would it make a difference either way?
Net Present Value of Money: A dollar today is worth more than a dollar in the future.
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. Why? Because theoretically 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 over 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 promised at some future time. But 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, converting it into more than one dollar. It could also be invested as a down payment on a type of asset that generates more money for you every month, for example. This explains in part why the value of money is related to time.
How does the time value of money relate to credit card debt? 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. You are spending the $800 now, losing the time value of that money, and conveying that benefit to the your creditor. What could you do with that $800 and what could you do with twelve of those payments ($9,600) in one year?
You don’t have to lose the time value of money with your creditors
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?