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How to Pay Off Your Debts to Improve Your
Finances and Retirement
Financial and Retirement Planning Information -
for Beginners
I read a lot of financial articles and so many of them don't apply to the average Joe. I read one recently that said, start saving money by passing up a Starbucks coffee every day. Well, I have never had a Starbucks coffee in my life.
When you clip coupons, eat hamburger and spaghetti, and only buy clothes for the kids, it is hard to cut back. You have to be spending money, before you can quit spending it.
Many of us do spend money on things we could cut out, but an awful lot of us don't! What is a luxury to some is a necessity to others. A newspaper may seem like a luxury, but if you are looking for a job, it is cheaper to have it delivered than to buy it on the stands, especially if you have to drive to get it. That newspaper is a necessity to the job seeker. What about the internet? Same deal. Where I live, local newspapers do not post classifieds online, unless you subscribe to that newspaper. Even if you have home delivery, you have to pay extra to access that same newspaper's website, so if I want to look for local jobs, I need to take or subscribe to that newspaper. The internet is necessary if I need to expand my job search, so I can't say, save money by dropping your internet service or your newspaper subscription. More and more, companies require you to apply online, so again, the internet is a necessary expense. I will say, look for ways to save money and if you find it, take advantage of it.
“Oh, there is he, some rich SOB telling me how to save money. He probably never had to worry,” you are thinking to yourself. Wrong! This is a case of do as I say, not as I have done. I have learned a lot from making mistakes, and I am passing my experience on to you. I have been in debt up to my ears, I have gone hungry. I was never homeless, but I came close. I was never out of work, but I didn't always make enough to make ends meet.
By using the principals outlined below, I paid off $150,000.00, in debt, including interest, in six years, earning less than $20,000.00 a year. I know, it looks like if I spent my entire income on those debts, I still could not have paid them off. Read on to find out how I did it by paying my debts off early and saving a bundle on interest.
The first thing you need to do to pay off you debts is not acquire more debt than you can afford.
The second thing is to get the right type of loan. If, possible, don't get a loan with a pre-payment penalty. If you have a pre-payment penalty, it will cost you a considerable amount to pay that loan off early; however, you may save more in interest, than your pre-payment penalty would cost you, so figure it out both ways.
On the other hand, if you have a loan that lets you pay it off early, it is fairly easy (assuming you can afford the loan in the first place), to pay that loan off early. By paying your loan earlier than the initial terms dictate, you: 1) save interest (money in your pocket), 2) help your credit and FICO scores, and 3) feel good about yourself.
So, how do you pay it off early? There are two main ways. Pay extra each time you make a payment, and to make payments more often.
For example: if you have a loan that is $91.78 a month for five years, and you make your regular payments, you will pay $1,101.36 a year, for a total loan payoff of $5,506.80.
If you round that payment up to $100.00 a month, you will be paying $8.22 extra each month, which adds up to $98.64 a year, making your total payment for that year come to $1,200.00. By rounding your payment up, you just made one extra payment that year. In 5 years, that comes to slightly more than 5 payments. But if you add on the interest you saved by making these payment early, it may come to another 2 payments (depending on your interest rate). Now you have paid off your loan 7 months early, and you didn't even feel the pain!
Another great, and to some, much easier way to pay off a loan earlier is to make a payment more often. Many people get paid bi-weekly, so this method fits right in with their take-home pay schedule. If you have the above $91.78 a month loan, instead of paying $91.78 a month, pay ½ twice a month. If you pay $45.89 every other week, you will be making an extra payment a year without doing anything else. At the end of the year, you will have made $1,193.14 in payments, exactly one extra payment.
That is because if you make monthly payments, you will be paying 12 times a year, but if you pay every other week, you will be making – not 24 payments a year – but 26. Right there you have gained 1 extra payment, without paying 1cent extra. Depending on your interest rate, you may gain another payment due to the interest you saved.
Now, what would happen if you combined the two methods? What if you pay every two weeks and round up? Lets see: You would pay $50.00 twice a month (26 payments), which would come to $1,300.00 a year. That is $198.64 a year more than your loan contract, which is more than 2 payments. Remember that this amount is not counting the interest you saved. In four years, you would have gained at least 8 payments, just on principal and at least 2 more on interest, so you just paid your loan off a full year, if not more, early.
You did all of that by paying an extra $4.11 a week and two extra payments a year! Now that didn't hurt at all, did it? If you make a ¼ payment every week, you would save even more in interest.
To make these methods work, be sure you tell your financial institution to apply the extra payment to the principal amount, not the interest. Loan payments always go to the interest amount first, unless you designate otherwise. This means that your loan amount stays the same.
If you owe $5000, and the interest on your payment is $10, and you make a $100 payment, $10 will go to the interest, and $90 will go to the principal. If you make a $110 payment, without designating the extra $10 goes to the principal, $20 will be applied to the interest, and you will still owe (and be charged interest) on $90. However, if you tell them to apply the extra $10 to the principal, your $110 payment will reduce your principal to $80.00.
These examples are based on a $5,506.80. Now think about doing that to a $50.000.00 loan. How about a $500,000.00 loan?!
These methods only work if your financial institution allows you to make payments using these methods, or if you would save more that a pre-payment penalty. Be sure to check it out before you take out your loan. If you applied for a loan at two places and one allows you to make extra payments and the other doesn't – all other things being equal – take the one that allows you to make extra payments.
One other thing you should know about making extra payments, is how your financial institution applies it to your loan. I have found that on the whole, credit unions are better at allowing you to make an extra payment, and they way they apply it can be beneficial to you if you get in a pinch on down the road.
Here's why. For this example, let's use different numbers. If your payment is $100.00 and you pay an extra $25.00 a month, in four months, you would have made an extra payment. Some places will credit you with the extra payment amount against your principal, but no matter how many extra payments you make, you still owe your next payment, in full, the next month, just as though you had not paid any extra. Some places, however, will credit you not only with the extra payment amount, but with an extra payment, as well. See what I mean: You owe $100.00 a month. In January, February, March, and April, you pay $125.00, so you have made an extra payment. Your next payment would not be due in May, but in June, because you made May's payment with the extra amount in the first four months.
Now don't be tempted to skip May. Just keep on making those extra payments every month, and you will see that it easy to pay that loan off early. If you happen to get in a real pinch, say you lost your job, or had to have an operation and missed work without pay for two months, THEN would be the time to take advantage of the months your payment isn't due, but don't waste them on something trivial, such as, “I'll just skip that May payment and buy me a new (insert something you don't really need here).
Just make sure your bank or credit union allows you to make payments in these ways before you take out that loan. You will find that most loan companies will not allow either of these methods.
If you follow these simple steps, not only will you pay off your loans early, you will greatly improve your FICO and credit scores, feel really good about yourself, learn a little bit about financial planning, and taken a step to getting out and staying out of debt, and maybe even get a jump on your retirement.
By applying these methods, if possible, to existing loans, you may be able to avoid bankruptcy, or debt consolidation.
If you have several loans, or credit card debt, start with the one with the highest interest and pay as much extra, as often as possible to that loan or credit card. When you get it paid off, take the money that you're paying on that loan, and pay that much extra to the loan with the next highest interest. It will be hard and it may take several years, but you can pay off your debts, assuming you have an income.
Once you have paid off all of your loans, take the money you were paying on them and put that in an IRA, 401k, or saving account. Don't start spending it just because you have it available.
If you do as I say, not as I did (I should never have gotten $150,000.00 in debt in the first place), you too can improve your financial and retirement situation.
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