Interest Income, Expense and the Rule of 72

How Long does it Take for Credit Card Balances to Double?

Nov 9, 2009

The Rule of 72 is a simple calculation with profound impact, which shows approximately how long it takes for a number to double based on the interest rate.

The time value of money is a key component in both investing and borrowing. Money that is invested earns interest, and over time, that interest is compounded, so that the balance grows.

The rule of 72 allows the user to quickly determine about how long it will take for money to double. Money invested at a constant rate of 6% per year will take around 12 years to double. This is calculated by dividing 72 by 6.

If the interest rate is 9%, it will take eight years to double. This can be proven out by the following table.

This example shows interest compounded at the end of each year, but in most instances, interest is computed monthly, so the amount will double even faster. At the end of 16 years, the amount will have doubled again, to around $4,000. These calculations assume an interest rate that does not change of the period of the investment or loan.

Implications of the Rule of 72 on Investing

The rule of 72 works both on amounts invested and borrowed; therefore it has implications for both interest income and interest expense. Money invested in a savings account at 1% will take about 72 years to double. This great number of years is one reason investors search for higher returns, but have to take on additional risk in order to realize them.

An investment in the stock market may result in a 10% gain, and if it could be duplicated would cause the funds to double in a bit over seven years. However, a 10% gain one year may be followed by a loss of 15% the next year.

Unpaid Credit Card Balances Double Quickly

Credit card issuers require that cardholders pay a minimum balance each month. If items are charged equal to the amount paid each month, the credit card balance will increase by the amount of interest charged each month. If the card has a typically high interest rate the unpaid balance will grow quickly.

As an example, assume a consumer builds a balance of $5,000, and continues to charge $500 a month and only pays that $500 per month, on a card with an annual 18% interest rate. The payments cover the purchases, but the interest on the unpaid balance will be $75 each month, or $900 per year. From the effect of compounding interest, the rule of 72 shows that the balance will just about double in only four years.

Getting compound interest to work for consumers is an important part of financial responsibility. Having it work against them leads to financial difficulty.

The copyright of the article Interest Income, Expense and the Rule of 72 in Accounting is owned by James Hutchinson. Permission to republish Interest Income, Expense and the Rule of 72 in print or online must be granted by the author in writing.