WHY THE BIG INTEREST IN INTEREST?

JENIPHER CHITATE

For the kingdom of heaven is like a man traveling to a far country, who called his own servants and delivered his goods to them. And to one he gave five talents, to another two, and to another one, to each according to his own ability; and immediately he went on a journey. Then he who had received the five talents went and traded with them, and made another five talents. And likewise he who had received two gained two more also. But he who had received one went and dug in the ground, and hid his lord’s money. . . . But his lord answered and said to him, . . . ‘So you ought to have deposited my money with the bankers, and at my coming I would have received back my own with interest’” (Matt. 25:14-26). This parable captures the essence of stewardship: profitable and faithful management of the talents and resources entrusted to us. From reading the Bible, it is clear that the lending of money for interest was a common practice in ancient times. The Bible provides several lessons on the subject of interest. We are expected to manage resources wisely (invest with an eye to generating interest, avoid collecting unfair interest from the poor and needy, and avoid paying unnecessary interest by avoiding debt). Last quarter’s article focused on getting out of debt using 1 Kings as an object lesson. Debt and interest are highly interconnected topics. This quarter we will share some basic concepts that will help boost your financial literacy in regard to

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interest. We agree that “ in the current economic environment of low interest rates and low growth, . . . it is important that everybody has the knowledge, skills, and attitudes to improve their financial outcomes and well-being.”¹

ASSESSING FINANCIAL LITERACY

As an entry point to the subject, it would be appropriate to lead church members in an assessment of their basic financial literacy. It has been established that financial literacy has a direct bearing on an individual’s financial well-being.²

According to Stolper and Walter,³ there are three questions widely accepted as the “Big Three” indicators of financial literacy. Below, we present two of these questions, which can be used as a self-assessment: 1. Suppose you had $100 in a savings account and the interest rate was 2% per year. After five years, how much do you think you would have in the account if you left the money in there to grow? The answer is: l More than $102. l Exactly $102. l Less than $102. l Do not know.

2. Imagine that the interest rate on your savings account was 1% per year and inflation was 2% per year. After one year, would you be able to buy: l more than, l exactly the same as, or l less than you could buy today with the money in this account? l Do not know.⁴ We have chosen these two questions because, according to Stolper and Walter,⁵ individuals who cannot answer both these questions are likely to make suboptimal financial decisions. If you feel you fail the test, please read on! This article will help boost your knowledge of interest. According to data from a survey conducted by the OECD International Network on Financial Education, many people do not have sound knowledge of interest and struggle applying basic interestrate concepts when making financial decisions.⁶ The survey results are significant as they represent findings of data collected from 30 countries encompassing “Africa, Asia, Europe, Australasia, North America and South America.”⁷

A USEFUL GLOSSARY

The meaning of several expressions related to interest in both specialized and promotional documentions are not clear for many individuals. As a result, important elements are overlooked, resulting in poor decisions.

WHAT IS INTEREST?

Basically, interest represents the cost of borrowing money; to a lender it represents income generated by lending money. Interest has many facets, and we will uncover some of these.

FIXED VERSUS VARIABLE INTEREST

Interest rates can be fixed or variable. A fixed rate is fixed over the term of the loan or investment. A mortgage with a 5% fixed rate over a five-year term,

means the interest rate will always be calculated on the outstanding balance at a rate of 5%. A mortgage with a variable rate is quoted as a premium or discount of an established rate, such as a lender’s prime rate. As an example, the premium or discount rate remains static (does not change); however, the prime rate can and usually does fluctuate, resulting in variable rates. The choice of selecting a variable versus fixed rate is not an easy one and is influenced by many things, including an individual’s ability to accept risk and fluctuating payments.

NOMINAL VERSUS REAL INTEREST

Nominal Interest rate refers to the rate of interest that is advertised. If during the year an investment generated 5% interest, the 5% is referred to as the nominal rate. This rate can be deceiving because it is not the real rate of interest. The real rate of interest takes into effect what is called the inflation rate. In our example, if inflation during the year was 2%, the real interest rate is just 3%. Most world economies have inflation targets and generally acknowledge that over time, we should experience some level of inflation. Inflation, according to Webster’s New World Dictionary is “an increase in the amount of money in circulation resulting in . . . the fall of its value and a rise in prices.”⁸ We all agree that a dollar today buys much less than it did 20 years ago. We can therefore say the value— or purchasing power—of money has decreased over time. This concept is extremely important when it comes to managing investments and retirement planning.

SIMPLE INTEREST VERSUS COMPOUNDED INTEREST

Simple interest refers to the calculation of interest based solely on the principal. On the other hand, compounded interest is calculated on the principal, plus the interest. Before signing a contract entailing interest, it is important that you understand whether the interest rate will be compounded or be based on simple interest rate. Compounded interest is a double-edged sword. It works in your favour if you are an investor as you earn interest on the interest. If you are the borrower, however, this can harm you financially, especially if you cannot afford payments to fully cover interest charges. You will end up paying interest on top of interest.

WHAT DOES GOD EXPECT FROM US?

The Bible recognizes the downside of interest and how this cost acts as a hinderance to getting out of debt. There are numerous verses, including Exodus 22:25; Deuteronomy 23:19, 20; and Proverbs 28:8 that forbid the charging of interest to poor individuals.

On the other hand, there is a recognition of interest as an avenue for growing wealth. In the story of the master who gave talents to his workers, the master says the one with one talent could have at least invested to earn interest (Matt. 25:27). There is also an expectation that a wise steward will not just let money sit in the bank but will seek wise avenues to invest and generate interest.

Finally! We hope reading this article has equipped you to share about the multifaceted nature of interest. Correct understanding of the topic is crucial to financial literacy and the exercise of proper stewardship of our God-provided resources. Research shows that increasing financial knowledge results in reduction of poverty and increased wealth.⁹ Why not make a commitment today to invest in more knowledge of this subject for yourself and for the benefits of communities? £

Jenifer Chitate

¹ OECD (2016), OECD/INFE International survey of adult Financial Literacy competencies, Paris: OECD ² M. Khalil (2020), “Financial citizenship as a broader democratic context of financial literacy,”

Citizenship, Social and Economics Education, pp. 1-14. ³ O. A. Stolper and A. Walter (2017), “Financial literacy, financial advice, and financial behavior,” Journal of

Business Economics, pp. 581-643. ⁴ O. A. Stolper and A. Walter (2017), Financial literacy, financial advice, and financial behavior,” Journal of

Business Economics, p. 590. ⁵ O. A. Stolper and A. Walter (2017), “Financial literacy, financial advice, and financial behavior,” Journal of

Business Economics, pp. 581-643. ⁶ OECD (2016), OECD/INFE International survey of adult Financial Literacy competencies, Paris: OECD ⁷ Ibid., p. 3. ⁸ Simon and Schuster (1980), Webster’s New World

Dictionary, New York: New World Dictionaries/

SImon and Schuster, p. 722. ⁹ M. Khalil (2020), “Financial citizenship as a broader democratic context of financial literacy,”

Citizenship, Social and Economics Education, pp. 1-14.