Get Rid of Debt Once and for All

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Categories: personal finance, debt, saving

“The time to save is now. When a dog gets a bone, he doesn’t go out and make a down payment on a bigger bone. He buries the one he’s got.”
Will Rogers

 I don’t think Will Rogers is suggesting dogs are smarter than humans, or maybe he is. Anyhow, in this instance, following a dog’s instinct may be a good idea!

Main Topic

It is very difficult to save if you are carrying credit card or any high interest debt. Let me explain why that is so, in simple language. Let’s look at Josh’s situation; he loves electronics, computer games, entertainment etc. and believes that since he has a job, he should reward himself by buying whatever he wants. And, like most ambitious young adults, he would like to go on nice vacations, get married in the future, and buy a home. Josh isn’t a big planner and is just happy to have graduated from college and gotten a job. Without even trying, he racked up $1,000.00 credit card debt. He doesn’t pay it off and he seems to adding a bit to it every month. Let’s break it down and see how, building up credit card debt makes it impossible to save for future goals.

1. Imagine that you owe $1,000.00 in credit card debt.
2. Every month that you do not pay that debt off IN FULL, you are being charged interest by the credit card company for the privilege of the loan they are making to you. Josh’s interest rate is 20%. That means, tack on 20% to any balance left on the credit card.
3. Let’s look at how it plays out. Imagine that Josh decides he’s not going to add to his debt and he will pay a few bucks more than the minimum payment on his card.

Current debt = $1,000.00

Interest rate paid to credit card company = 20%

Monthly payment = $30.00

Months to pay = 48 (that’s 4 years)

Total interest paid = $435.00 (on top of the $1000.00)

Josh doesn’t like that scenario and decides to tighten his belt and pay $150.00/month to his $1000.00 debt and not add to it!

Current debt = $1,000.00

Interest rate paid to credit card company= 20%

Monthly payment = $150.00

Months to pay = 8

Total interest paid = $50.00

See here’s the deal; if you only pay the minimum payment, and don’t even add to the balance, you can end up paying a ton of interest. Josh paid a couple of bucks more than the minimum in the first example and paid an additional $435.00 in interest on top of the original $1000.00.

Would you buy those same electronic games if they cost 50% more than you originally paid for them? I don’t think so.

As you saw in the second example, Josh sucked it up and found $150.00 each month to pay to his debt and didn’t add to the debt. In 8 months he got rid of the credit card debt. By increasing your payment, you can markedly speed up your debt repayment.

Let’s reverse the situation and pretend Josh has zero credit card debt and wants to start saving for his future goals.

Monthly saving payment = $150.00

Interest rate paid by bank = 1.5%

Balance after 8 months saving = $1,213.00

Total interest received = $6.83

Practical Application

ü      If you use the $150.00/month to save, at the current savings rates, you earn about $7.00 over 8 months. I know $7.00 isn’t much, but getting $7.00 is still better than paying $50.00 interest .

ü      So, unless the interest rate on your savings account is higher than the interest rate charged on your credit card, carrying a credit card balance is a losing proposition.

ü      Ask yourself would you rather get $7.00 or pay $50.00?

Clearly, the takeaway is that in order to reach your financial goals, you must eliminate credit card debt.

 Some of you may look at that puny interest rate on savings and cringe. Actually, I’m one of those who cringe at the low interest rates on my savings. Don’t worry about the interest rate right now. You see, interest rates go up and down, and you have no control over the interest rates at all. And regardless of how much interest you are receiving on your savings right now, it is better to receive any amount than PAY interest on your debt.

 As long as you are carrying credit card debt, not matter how much you save, you lose! You gain more financially by eliminating credit card debt balances than by saving.

 Pay off debt 1^st, and then save!

Action Steps

Get a notebook and label it: “(your name) Personal Finance” and keep it by the computer. Use it for all of your personal finance goals, thoughts, activities, and plans.

1. Go to an online calculator such as these at bankrate   and moneychimp.  Plug in different repayment amounts, to see the impact on how fast you can pay off the debt.

2. Write down the amount you are willing to commit to debt repayment in a visible place, list a couple of spending items you will reduce, and PAY OFF THE DEBT.

 To read more on this topic, go here.