On a recent post, I talked about how to calculate your debt’s weighted average interest rate. Simply put, if you have a $1000 debt at 6% and a 2000% debt at 0%, your total debt is $3000 at 2%. That rate is important because this is how much that debt money is costing you.
Paying debt is a burden for everyone. I have a mortgage, and some consumer debt that could be considered ”good debt” since I took those loans to invest, not to buy stuff. Even so, I don’t like the feeling of being indebted, and I don’t like paying interest. I choose not to repay my debt faster because I need this money to invest and reach financial independence faster. Which doesn’t prevent me from trying to repay the minimum amount in interest.
In order to reduce payments on your debt, you can either reduce the capital repayment, the interest rate or both.
Reducing capital repayments on your debt
Reducing the capital will likely lengthen the repayment period. Except in the case of a 0% balance transfer. I took one this summer and I don’t need to pay the capital until next June. Every month, I pay 1% of the balance, but will need to pay a big lump sum or find another 0% transfer in June or I will start paying some crazy interest on the card.
A 0% balance transfer is a good thing if you are sure you will be able to repay the debt by the end date, or transfer to another 0% card. All payments (except a 3-4% fee) will go towards the principal of the debt.
All your different credits will be bought by one company. You will have one monthly payment instead of many, and one interest rate. IT MAY BE LENTHY AND VERY COSTLY. Before you opt for debt consolidation, do your homework. Calculate the weighted average interest rate on your debt to make sure you get a better rate. Since your payments will usually be lower, try to make extra payment and repay faster.
Reducing the interest rate on your debt
A few options to consider are
I used to have a 2.94% mortgage, with 25% down, that was already considered a low rate. Out of curiosity, I checked what other rates my same bank was offering, via online banking, and found out I could remortgage at 2.29% with a $150 fee. There was no paperwork involved and I got back the $150 fee in no time. Had I not asked for it, I would still be paying a higher rate on my mortgage. Be proactive! Your bank will not come looking for you to offer you a special rate.
Paying debt faster
Making extra payments on your mortgage and other debt with reduce the length of your loan, and therefore the interest paid on it. There are great calculators out there to find out how much interest you can save by adding an extra $50 to your monthly repayment. The savings are amazing, and you should really have a look for yourself, because it is a great motivator to repay early. You should be comfortable with the extra payments. If you stretch your finances too much in order to repay a 4% mortgage, you may have to resort to a 19% credit card to end your month, and all your hard work will end up costing you more.
If you try to put any extra money towards your debt, freelance income, a windfall, found money, money saved by getting a deal or taking lunch to work, you will see that your debt shrinks quickly.
Take a secured loan against your house
If you have some equity on your mortgage, your bank should be happy to lend you money, securing the loan against your house. This is a risky move. If you owe money on your credit card, you do not risk foreclosure. If you are unable to pay your secured loan on the other hand, the bank can put your house for sale. I wouldn’t do it unless I was 100% sure to make my payments in time. If you know you can, the rate will be much lower than the one on your credit card.
Finding other sources of lending
My mum is my favorite bank. She has a good chunk of cash on a 2% savings account. In order to make things fair for everyone, I borrow from her at 4%. No fees, no credit check, and no specific term. When I am done, I give her back the money, plus interest. I never borrow from her for a risky operation. Usually I have other higher yielding investments that come to term a few months later and borrow some cash in the meanwhile. Borrowing money from a friend of family and failing to reimburse them can lead to great trouble and damage your relationships.
Peer to peer lending
Instead of borrowing from a friend, or the bank, you borrow from savers who have cash. The rates are higher than a consumer loan, but lower than credit cards. Depending on your credit score, they make you an offer on the amount and the rate. Look for reliable peer to peer websites, and never pay money upfront to secure the loan.
If you really have no other solution, and can’t make your monthly payments, bankruptcy is your last move. Look for advice first, from a Citizen Bureau or a debt agency, many offer free debt counseling. This will ruin your credit score and you won’t be able to borrow money for years. During the bankruptcy process, your lenders will generally agree on a lower repayment amount, and the interest on the debt can be frozen. Depending on your income and expenses, a monthly repayment amount will be determined. You cannot default on those payments, which may even be taken directly from your salary. Resort to bankruptcy if you really have no other option.
How do you reduce your debt payments?