Have debt and want to optimize your path to debt free? Well go no further weary traveler, I’ve got the sweet sweet info you crave. The way we are going to look at your debt may be a bit different than you’ve looked at it before.
Debt is like investing, you can do it in multiple ways but there are ways to optimize your dollars. Something that makes debt easier than investing, however, is definite interest. When it comes to debt the point is to avoid paying it instead of trying to gain it. So not quite as fun, but important none the less.
So first, what do I mean about definite interest? When it comes to investing, we talk about assumed interest based on historical data that we then use to project our earnings. This is where our “assumed 8% gain” comes from. For debt the interest is actually written in a contract that locks that interest rate in, except for in specific situations. So when you pay $100 back on a loan charging you 10%, you KNOW that you actually saved yourself from paying $10.
The very first step is paying down debt is to make sure you are at least paying the minimum due to preventing late fees. We want to focus on the interest, and late fees would create an extra layer of cost. So put the minimum due for all your debt on auto-pay.
Now that that’s taken care of, we can get into the meat of debt repayment. A common question is how to prioritize your repayment. Often, people try to pay a little extra on everything. Don’t do that. You are going to want to put EVERY DOLLAR that you don’t need to survive, and isn’t going into those other minimum payments, into the loan with the highest interest rate.
Let’s follow that with a little concept I like to call dollar tracking. If you have 1 dollar to put toward a loan, what would it do in each loan?
THE CASE STUDY!!!
Let’s say you’ve got $50,000 in student loans, $5,000 in credit card debt, a $10,000 dollar car loan, and $100,000 in a mortgage.
Option #1 – The Student Loan
According to Nerd Wallet (great source of info btw), the average student loan interest rate is 5.8%. So let’s apply our single dollar. Each dollar is getting charged just under $0.005 in interest every month. So by using your dollar on the student loan, you are saving yourself from paying half a penny in interest this month.
Option #2 – The Credit Card
Nerd Wallet has again done the heavy lifting with the information that the average credit card interest rate is 16.97%. So what is it per dollar per month? Roughly $0.014. A whole penny and a half almost. Keep this in mind! We’ll summarize at the end.
Option #3 – The Car Loan
This time brought to you by Value Penguin, the average interest rate on a car loan is 5.27%. So let’s math this out. That would be $0.0044 per dollar per month.
Option #4 – The Mortgage
The interest rate here is generally around 4% according to Value Penguin again. This means we are talking about $0.0033 per dollar per month.
For every dollar you put into each of these loans, you would be saving yourself from paying the amount we found here. So let’s rank our options!
- $0.014 – The Credit Card
- $0.005 – The Student Loan
- $0.0044 – The Car Loan
- $0.0033 – The Mortgage
What does all this tell you? For every dollar that you use to pay off your student loan instead of your credit card, you are net losing $0.009!! (0.014-0.005=0.009)
Just like everything else, there is an optimal way to pay down debt, and sometimes that means neglecting certain accounts. THAT’S OKAY. Pay off what is charging you the most that way when you get to those larger accounts charging relatively less in interest, you can focus and be at your best financially.
This post is one that I think a lot of people need so please, send this to a friend that has debt. This post could save them tens of thousands of dollars by the time they are done paying off debt.
Thanks for reading