Charles Brown writes: >> What is the logic supporting the idea that interest should be paid for money >> lent ? I believe many or most mortgages have more interest paid than >> principle. In part this is done by payments being allocated to interest >> payments before being allocated to principle payments. How is this >> rationalized by economics ? How is wealth created by the lending of money to >> buy a place to live ?
You are asking an age-old question. Smart people going back to Aristotle have thought there is something wrong with interest on money lent. The logic of interest ultimately goes back to the principle that human beings would rather consume today then consume tomorrow (i.e. they value the present more highly than the future). If I offered you a dollar now, or offered you a dollar next year, would you think both offers were of equivalent value? If you do, there is not much to say. If you agree they are different, then you can see that if I have a dollar, and you ask me to exchange that dollar for the promise of a dollar next year, it is not an equal exchange. Interest is what balances the transaction. Related to this is the question of whether you should consume what you presently have, or defer present consumption in order to invest in capital, which will enable you to consume more in the future than you would if you consumed now and did not invent in capital. Interest is a price signal that helps to regulate what is presently consumed as opposed to what is invested for future consumption. Regarding the housing market, if there was no lending, it would be by definition impossible for anybody ever to buy a house unless they had current resources in excess of the price of the house. That would restrict home ownership to very few people and the majority would be required to rent. For most people, home ownership is a very good investment compared to renting. David Shemano
