Have you ever stopped to think about how expensive being in debt is? Or how much it’s truly costing you?
Yes, you’re (hopefully) making regular monthly payments, but are you aware of how large a part your interest rates play in your debt? After all, interest is the high cost we pay to borrow money.
Let’s look at an example. If you have a balance of $13,986 on a loan, at a 6.8% interest rate, and you’re on a 10 year repayment term, your monthly payment is $160.95. If your loan were to start today, $79.25 would go straight toward interest, leaving only $81.70 to go toward your principal. Ouch!
Thankfully, the further along you get with paying your loan off, the less you’re paying toward interest. By your 52nd monthly payment, only $51.97 is going toward interest, and by your 90th, $25.86.
You Can Use Interest as a Motivator to Pay Off Debt
In the meantime, it can be downright depressing to realize just how much of your money is going toward interest rather than the principal. I know it was one of the biggest wake up calls for me when I ran the numbers on my student loans.
My minimum monthly payment is $136, and currently, $45 – $50 goes toward interest each month. It feels like I’m barely making any progress.
Furthermore, the longer you take to pay off your loan, the more expensive it becomes, all thanks to interest. Need another example?
Let’s go back to that balance of $13,986. You’ll actually end up paying $5,328.23 just in interest over the life of the loan. That means your loan is costing you $19,314.23!
Once I realized this, I decided to channel my disappointment into motivation. Once you see how much you’re paying toward interest (have a look at your accounts), you might wonder how you can start paying more toward principal. It’s not fun being a slave to interest, and it doesn’t have to stay that way.
Here are a few tips on how to beat interest.
Pay More Often
One of the easiest ways to pay less toward interest is to pay more frequently. Most debt repayments occur once per month. Try dividing that up and pay biweekly, or even weekly, instead of once per month. You can do this using a few methods.
This is a popular method for paying off a mortgage, but you can use it for any kind of debt. Normally, you’d pay once per month, resulting in 12 payments per year. By paying biweekly, you’re making 26 payments per year (thanks to those two extra paycheck months), or 13 full payments, instead of the normal 12.
If your normal payment is $500 per month, you’d pay $250 biweekly. This is also less of a hit to your bank account if you don’t get paid weekly.
Use the Snowflake Method
This is a combination of the debt avalanche and snowball methods. Any time you get extra money, you throw it immediately toward the debt you’re focused on paying off. If you want to focus on the debt with the highest interest rate, then direct all extra payments toward it.
Do this even with smaller amounts. $5 here and there can add up, and it will cause the balance to fall even faster. By chipping away at your debt piece by piece, you’ll feel less overwhelmed and more accomplished.
If you don’t think you can use all the extra money for your debt, do yourself a favor and open a separate bank account for the funds. Any time you get extra money, direct it to that account, and set your debt payments to debit from there. Just like your emergency fund is used only for emergencies, this fund should only be used to pay off debt.
Pay Extra When Possible
As you can see, along with paying more often, you should also be paying more than the minimum – however much you can afford. That’s why side hustling tends to help, especially if your salary isn’t amazing, or if you don’t have extra room in your budget.
Let’s go back to our first example. Your monthly payment is $160.95, and you’re paying a total of $5,328.23 in interest. By paying $200 per month instead, you lower the amount of interest paid to $3,874.94. Not bad for an extra $40 per month!
I’ve consistently made extra payments toward my student loans, and I’m paid ahead until next year. How have I done that? It’s been a combination of working overtime, and putting any extras like birthday money or tax refunds toward my balances. My student loans are my #1 priority, and I’m prepared to continue my assault until they’re paid off.
That may sound a little extreme, but I can’t tell you how annoying it is to pay the minimum and watch it barely make a dent. I’m sure some of you are in the same boat.
If you’re serious about paying off your debt, you need to dedicate at least some portion of extra funds to paying it off quicker.
Use the Debt Avalanche Method
This is my personal favorite way to pay off debt, but it’s not for everyone. It’s a mathematical approach to paying off your balances, as you’re going to be focusing on paying off your debt from the highest to lowest interest rate.
If you have 4 debts you’re paying back, with interest rates of 3.5%, 8.5%, 11%, and 15%, you’ll want to target the 15% debt first.
How can this save you money? By paying off your debt in order of highest to lowest interest, you’ll pay less in the long run because the higher interest debts are costing you more each month, especially if they have higher balances.
Think of it this way – interest is being accrued at a faster rate, and paying the minimum, or spreading your extra payments out, isn’t effective. You’re not going to get ahead because the interest is constantly accruing.
Try Getting Your Interest Rates Lowered
If you have credit card debt, it might be worth looking into trying to negotiate a lower interest rate. Credit card interest rates are some of the nastiest out there, and it’s very easy to get caught in an expensive endless cycle of debt because of that.
Call up your credit card issuer and explain your situation. If you’ve never paid late before, and pay over the minimum, that speaks for itself. They’ll be more willing to work with someone already showing the effort. Be polite, too!
If they can’t do anything, it was worth a shot, right? Set a reminder to call back every month, or every other month. Getting a different representative, or making more progress, may help.
If you have other loans, refinancing might be an option. It’s not for everyone, though. Only look into it if you’re struggling to pay your loan back, or if it will save you a great deal of money until you can pay off your loans.
Overall, there’s no reason to continue to be a slave to interest. Once you’re aware of how costly debt is, you can get to work on paying it off.
Do you pay extra on any debt you have, or do you make frequent payments toward your loans? Have you accelerated your debt repayment?