It’s something most people aren’t comfortable talking about. Some individuals even go as far as ignoring it until “it just goes away.” I used to be one of these people. If I just ignored that late payment notice long enough, or if I only paid the minimum payment on a statement and didn’t look at the mounting interest, then it would all go away eventually. It didn’t. It’s not something you can brush off or be afraid of dealing with. Not until I got real about how much I owed and how much money I was losing in interest payments, did I realize its significant financial impact.
Before anything, You should not be paying any more than the minimum payment on loans until you have an emergency cushion that you can fall back on in case you lose your job or an emergency happens. If this were to happen, not only could you not pay off your debts and they would default anyway, you might not be able to afford a place to live or feed your family. Build yourself an adequate Emergency Fund before anything else. You may really need it one day.
Once you have an Emergency Fund in place, you cannot truly begin to save or invest your money until you get rid of high interest debt weighing you down. It sucks to hear and for some people it is extremely hard to get out from under. If you have the know-how and drive to do it, even if it takes years, you can do it! One of the best feelings I’ve ever had was the day I didn’t owe a single person a dime. It was a tremendous weight off of my shoulders. It took time and some real grinding to accomplish. It will for you too, but I have faith in you.
The first thing you need to do is get real about your debt like I did. Not only did I owe $20,000 in student loans but I had a car payment and personal loans that totaled over $10,000. Credit Cards used to be a big problem for me because I didn’t really know what I was doing when managing them. $30k may seem like a small amount of debt to you, or a large amount. I doesn’t matter. The point is, it’s money that you owe someone, that is tied up and actually costing you money.
Some common reasons I see military personnel go into debt are:
- Pay is steady but for some families it can be small compared to family size
- Relocation (including rent deposits, storage, furniture, transportation)
- Excessive Car Payments or being Upside-down on a car loan
- They are susceptible to living outside of their means
How Loan Holders Make Money Off of You
When you apply for a loan, whether it be for a car, a credit card, cash money for a renovation, student loans or a mortgage, they tend to do so expecting something in return. This is an incentive for them to part from their money and give it to you. The amount you give them back is called Interest. This is the only reason they are interested in you in the first place. When you apply for a loan they will give you an Interest Rate, which is based off of your FICO Credit Score. The better your FICO score the lower your Interest Rate will be, aka the less money you have to pay them back on top of the original loan. The idea behind this is to reward individuals for being good users of credit, which they track over the years.
A simple example would be:
A car dealership gives you $10,000 for a car loan. This is the Day 1 Principle Balance. The principle balance is the amount due to satisfy complete payment. The rate they charge you based off of your FICO score is 4%, which is on the high side but average for someone with limited credit history. As months go by, the interest rate will accrue and add to the principle balance. The ‘term’ or length of the loan, is 60 mo.
Over the course of that loan you will end up paying $11,050 for a $10,000 car. Not to mention the value the car loses over time (depreciation) and money you could have invested during that time and received a return on.
This is just one example obviously. Prices, rates, and length of loans will be different. But bare in mind that you will be paying more for most of the products that you buy on a loan. I know that’s the point of getting a loan…we want to get that product without having to save the cash to buy it all at once. Mortgages excluded, if you choose to do this you will literally pay the price for it. God forbid you drove a beater while you saved cash for that $10,000 or $20,000 car. Who wants to be seen in a $2,000 Corolla right!? Maybe think about what’s motivating you to buy things on credit. If you can’t pay cash for something can you afford it? When you take out a loan, you can’t afford to buy that item. You are asking for someone to help buy it for you. I’m not saying it’s right or wrong. Just think about it.
This same situation accounts for Student Loans, Mortgages, Personal Loans and Credit Cards, some of which are necessary evils.
I will never judge anyone for having a tough time and they need some help, so they take out a loan. But if you set yourself up with an emergency fund and save cash for your larger purchases you will avoid one of the simplest pitfalls that people make with their finances.
Hopefully this helps you understand how a loan works and how you are losing money in interest, so ok
What is The Best Way to Attack Your Debt
If you’re just getting started with your debt repayment plan, make a list of all the debts that you have. On that list, also note the interest rate or any other fees that you may be paying. Get a free copy of your credit report to back yourself up and make sure all of your debts are listed and in the proper status. I suggest CreditKarma.com or Experian.com.
The next thing you should do is call your loan holder for each account and see if it is possible to reduce your Interest Rate or Principle Balance. Most people don’t know that you can potentially negotiate your Interest Rate while you are making payments on a loan. Even if you can go from 4.5% down to 4.25% you will save some money! You could even possibly negotiate a reduced Principle Balance. Maybe the company is willing to knock off a few hundred dollars if it means they can collect their money faster. You’ll never know if you don’t talk to them. It’s worth a shot isn’t it?
Once you’ve attempted to negotiate your rate or balance, it’s time to begin throwing money at your debt. Like I said before you cannot meet any significant savings goals or make any actual investment returns if you owe money to someone (excluding a mortgage). For every dollar you make investing or putting away in savings a percentage is going to someone else you don’t even know.
You should be paying at least the minimums on all debt accounts so that they do not go into default. Once you have verified that you are, Debts should be paid down in order of interest rate, starting with the debt that carries the highest interest rate. This is the financially optimal method of paying down debt because simply, they are getting more money from you per dollar.
As an example, a you have the following situation:
- Loan A: $1100 with a minimum payment of $100/month, 5% interest
- Loan B: $3300 with a minimum payment of $300/month, 10% interest
- Leftover Income, not used on essentials: $1300
You need to first pay $100 + $300 = $400 to make the minimum payments on loans A and B so the payments are recorded as “on time.” The extra $900 should go to Loan B (highest interest rate).
Another common approach individuals take to paying off debt is the highest loan amount (principle balance) first and so on…This approach will certainly give you a psychological boost! Boom another loan payed off completely! Also seeing big loan numbers become smaller is a great feeling. By all means if you want, you can do this, but keep in mind that the higher interest rate is costing you more money.
Regardless of which approach you choose, your number one goal should be to become 100% debt free. Once you don’t owe anyone money, any return on investments you get will be profit. Every month you will have extra money in your account to invest or spend how you see fit. It is extremely difficult for some people to get out of debt but it will literally change your life. You will experience a relief of burden that few people get the opportunity to feel financially in life. Not only that but you can begin to invest your money and start making it work for you instead of the other way around.
Hey, it’s Kailua! I found this on Google!
*To be clear I am not advocating that you don’t use Credit Cards as a form of debt, I do everyday. Just be sure you are paying them off IN FULL every month so that they cannot charge you any interest. The rewards on some cards alone is worth their use and I will cover some of them at a later time.
*I am also not advocating that you don’t take out a Mortgage on a home, I’m about to take out a loan myself on a modest home. But if you are thinking of buying a home, think about how much space you REALLY need, you will truly pay for every square inch in the long run, also consider making a larger down payment (20%-40%) if you can (I know zero down is so ‘in’ right now with my military friends through the VA). You will enjoy a smaller interest rate and shorter ‘term’, aka, length of loan time if you do. If you already own a home, consider renegotiating your Interest Rate or make payments larger than the minimum amount due. You will pay off your home sooner and give the bank less time to take your hard earned money.
As always if you have any questions, knowledge or personal experiences to share with me or others, please leave a comment. I would love to have a discussion or an opportunity to learn more.
-Matthew Bunting (Bunts)