Carrying a heavy debt load for many years can prevent you from truly enjoying your money. Large debt payments can make it impossible to save for retirement, and the pressure of all those bills can tie you to a job you don’t enjoy. That’s why making debt repayment a priority can be hugely rewarding. Here’s how to get started.
If you have a lot of consumer debt -- a car loan, several credit cards, maybe a line of credit -- your first step is deciding on the best strategy for paying it down. Let’s say you have four different debts and can afford $600 a month in payments. Should you throw $150 at each one?
No, say financial experts who teach the “snowballing” method. It’s better to attack the debt with the highest interest rate first. Each month, pay the minimum on the other three debts, then take whatever’s left of your $600 and apply it to your high-interest target. When that debt is paid off, move on to the one with the next highest rate and do the same thing. You’ll always be paying $600 a month, but you’ll reduce your debt much faster than if you had spread that money evenly.
If you’re not carting around much high-interest debt, you can turn your attention to your mortgage. After all, although your home loan probably has a lower rate than any of your other debts, you’re probably still paying thousands of dollars a year in interest. Let’s assume you’re borrowing $150,000 at a fixed rate of 6 percent. Consider these three strategies for paying down this mortgage quickly:
• Refinance to a shorter term. Paying off your mortgage in half the time doesn’t mean paying twice as much each month -- not even close. With a 30-year term, your monthly payment would be $900. Choosing a 15-year term, however, will cost only $365 more per month. The shorter term will enable you to own your home a decade and a half sooner and would save you a staggering $96,000 in interest.
• Annual prepayments. Some lenders allow you to make a “prepayment” once a year to reduce your principal. These top-ups can help you pay your mortgage off much more quickly. Using the above example, an annual $2,400 lump-sum payment would knock more than 10 years off your term and save you $67,000 in interest. If coming up with $2,400 all at once is difficult, try tucking away $100 with every bimonthly paycheck.
• Make biweekly payments. If you get paid every other week, consider making biweekly mortgage payments of $450. You’ll probably notice no difference in your cash flow, but you’ll be paying an extra $900 a year. That’s because, since there are 52 weeks in the year, you will be making 26 biweekly payments -- the equivalent of 13 monthly mortgage payments instead of 12. That will allow you to pay down the loan five years faster and save you more than $38,000.
Of course, all of these debt-reduction methods require coming up with extra money each month. Where are you going to find it? One way is to reconsider the car you’re driving. If you’re leasing or buying new wheels every four years, you can save a bundle of money by choosing a used vehicle instead. If you’re a two-car family and you live in a city with good public transportation, you might consider getting rid of your second car. What you save in car payments, gas, parking, maintenance and insurance will allow you to direct hundreds of dollars toward your debt every month.
You can also make small daily sacrifices to free up extra money. Exchange your morning latte for a mug of home-brewed coffee and you can probably pocket $50 a month. If you’re a couple that goes to the movies twice a month, rent DVDs instead and you’ll be up another $60 or so. Use the library, cancel unnecessary phone and cable services and buy and freeze meat when it’s on sale. If you can find little ways like this to save $20 to $30 a week, you’ll be well on your way to ramping up your debt payments and getting out of the red.
No, say financial experts who teach the “snowballing” method. It’s better to attack the debt with the highest interest rate first. Each month, pay the minimum on the other three debts, then take whatever’s left of your $600 and apply it to your high-interest target. When that debt is paid off, move on to the one with the next highest rate and do the same thing. You’ll always be paying $600 a month, but you’ll reduce your debt much faster than if you had spread that money evenly.
If you’re not carting around much high-interest debt, you can turn your attention to your mortgage. After all, although your home loan probably has a lower rate than any of your other debts, you’re probably still paying thousands of dollars a year in interest. Let’s assume you’re borrowing $150,000 at a fixed rate of 6 percent. Consider these three strategies for paying down this mortgage quickly:
• Refinance to a shorter term. Paying off your mortgage in half the time doesn’t mean paying twice as much each month -- not even close. With a 30-year term, your monthly payment would be $900. Choosing a 15-year term, however, will cost only $365 more per month. The shorter term will enable you to own your home a decade and a half sooner and would save you a staggering $96,000 in interest.
• Annual prepayments. Some lenders allow you to make a “prepayment” once a year to reduce your principal. These top-ups can help you pay your mortgage off much more quickly. Using the above example, an annual $2,400 lump-sum payment would knock more than 10 years off your term and save you $67,000 in interest. If coming up with $2,400 all at once is difficult, try tucking away $100 with every bimonthly paycheck.
• Make biweekly payments. If you get paid every other week, consider making biweekly mortgage payments of $450. You’ll probably notice no difference in your cash flow, but you’ll be paying an extra $900 a year. That’s because, since there are 52 weeks in the year, you will be making 26 biweekly payments -- the equivalent of 13 monthly mortgage payments instead of 12. That will allow you to pay down the loan five years faster and save you more than $38,000.
Of course, all of these debt-reduction methods require coming up with extra money each month. Where are you going to find it? One way is to reconsider the car you’re driving. If you’re leasing or buying new wheels every four years, you can save a bundle of money by choosing a used vehicle instead. If you’re a two-car family and you live in a city with good public transportation, you might consider getting rid of your second car. What you save in car payments, gas, parking, maintenance and insurance will allow you to direct hundreds of dollars toward your debt every month.
You can also make small daily sacrifices to free up extra money. Exchange your morning latte for a mug of home-brewed coffee and you can probably pocket $50 a month. If you’re a couple that goes to the movies twice a month, rent DVDs instead and you’ll be up another $60 or so. Use the library, cancel unnecessary phone and cable services and buy and freeze meat when it’s on sale. If you can find little ways like this to save $20 to $30 a week, you’ll be well on your way to ramping up your debt payments and getting out of the red.
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