In a recent post, I discussed how to calculate your debt’s weighted average interest rate. Essentially, if you owe $1,000 at 6% and another $2,000 at 0%, your total debt of $3,000 has an average interest rate of 2%. This rate is crucial because it shows how much your debt is costing you in interest.
Dealing with debt is challenging for everyone. Personally, I have a mortgage and some consumer debt that could be considered “good debt” since it was used for investments rather than purchases. Nevertheless, I dislike being in debt and paying interest. I choose not to repay my debt faster because I need the money to invest and achieve financial independence more quickly. However, this doesn’t mean I don’t try to minimize my interest payments.
To lower your debt payments, you can reduce either the principal amount, the interest rate, or both.
Reducing Capital Repayments on Your Debt:
Reducing the principal payment often extends the repayment period, except in the case of a 0% balance transfer. I used one this summer and don’t need to pay the principal until next June. Each month, I pay 1% of the balance, but by June, I’ll need to pay a lump sum or find another 0% transfer to avoid high interest on the card. A 0% balance transfer works well if you can repay the debt by the end date or transfer to another 0% card. All payments, except a 3-4% fee, go towards the principal.
Debt Consolidation:
Debt consolidation involves one company buying all your different credits, so you make one monthly payment at one interest rate instead of many. It can be lengthy and costly, so do your homework first. Calculate the weighted average interest rate on your debt to ensure you’re getting a better rate. With typically lower payments, try to make extra payments to repay faster.
Reducing the Interest Rate on Your Debt:
There are several options to consider:
Refinancing Your Mortgage:
I used to have a 2.94% mortgage with 25% down, which was already low. Out of curiosity, I checked my bank’s online rates and found I could refinance at 2.29% with a $150 fee. There was no paperwork and I recouped the fee quickly. Be proactive; your bank won’t offer you a better rate unless you ask.
Paying Debt Faster:
Making extra payments on your mortgage and other debts reduces the loan length and the interest paid. There are calculators available to show how much you can save by adding an extra $50 to your monthly payments. The savings can be significant and motivate you to repay early. Ensure you’re comfortable with the extra payments to avoid financial strain that might force you to rely on higher-interest credit cards.
Using Extra Money to Pay Down Debt:
Apply any extra cash from freelance income, windfalls, savings from deals, or even brown-bagging your lunch towards your debt, and you’ll see it decrease quickly.
Secured Loans Against Your House:
If you have equity in your mortgage, banks might lend you money with the loan secured against your house. This is risky because failing to repay might lead to foreclosure. Only consider this if you’re 100% confident in making timely payments, as the interest rate will be much lower than on credit cards.
Finding Other Sources of Lending:
My mom is a great lender for me. She has cash in a 2% savings account, and I borrow from her at 4% without fees, credit checks, or strict terms. I never borrow from her for risky operations, only when I have higher-yielding investments maturing soon. Failing to repay friends or family can strain relationships.
Peer-to-Peer Lending:
Instead of borrowing from friends or banks, you can borrow from savers who have spare cash. The rates are higher than consumer loans but lower than credit cards. Based on your credit score, you’ll get offers on the amount and rate. Look for reputable peer-to-peer lending websites and avoid those that ask for upfront fees.
Bankruptcy:
If you can’t make your monthly payments and have no other options, bankruptcy is your last resort. Seek advice from a Citizen Bureau or debt agency, many offering free counseling. Bankruptcy will ruin your credit score, preventing you from borrowing for years. During this process, lenders usually agree to lower repayment amounts, and interest can be frozen. Your monthly repayment amount will be determined based on your income and expenses, and you must not default on these payments, which might even be deducted directly from your salary. Consider bankruptcy only as a final option.