Americans Are Unprepared for The Rule of 72

One of the simplest and best ways to think about the impact of interest rates is to use the Rule of 72. It’s a rule of thumb used to determine the number of years it will take to double your money at a given interest rate.

You simply divide the number 72 by the interest rate, and the result is the number of years it takes to double your money. For example, if you can get an interest rate of 5%, then you will double your money in just over 14 years (72 / 5 = 14.4).

Sadly, the rule also works if you want to calculate how long it will take to double your debt if you’re paying interest instead of receiving it. Let’s say you owe $20,000 on a credit card and the bank is charging you 20% on the unpaid principal balance. Now, the math is horrible. Your debt will double in about three-and-one-half years (72 / 20 = 3.6).

Assuming you pay the minimum monthly amount and your new charges are about the same, the principal owed on the card will go from $20,000 to $40,000 in 42 months on the interest alone.

Does your bank charge 30% interest? Some do. In that case, you’ll go from $20,000 to $40,000 of debt in just 28 months.

Again, that’s from the impact of interest on unpaid balances without counting any new charges. Basically, your credit card is maxed out, and you’re in a kind of debtor’s prison. The only escape is default or bankruptcy, which kills your credit rating.

It also puts the loss on the bank, which will have its own problems if enough people default. That scenario is starting to play out in the U.S. economy, according to Bloomberg News.

Credit card delinquencies hit an all-time high in the fourth quarter of 2023, according to the Federal Reserve Bank of Philadelphia. The share of credit card accounts making the “minimum payment” (meaning customers can’t pay down the balance) rose 34 basis points, also an all-time high.

This credit card data is bad news in three respects. First, it means consumption will slow or decline if credit card balances are maxed out. Second, it means that bank balance sheets will contract as consumer credit losses pile up. And third, it’s a reliable leading indicator of a recession for which most Americans are unprepared.

You don’t need a math Ph.D. to figure this out. Just use the Rule of 72.

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