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.
Debt consolidation
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
Refinancing your mortgage
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.
Bankruptcy
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?
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We are debt free aside from our mortgage! Yay for that. We did refinance it though to reduce the term. It saved money and time as well. It was definitely a o brainer.
Sorry this isn’t a comment about this post but – nice new theme! I plan on making a switch sometime over the next few months. I like the look!
It is supposed to be a bit like thesis, that’s why you like it, thanks!
I agree with DC, like the new theme! The only debt we have remaining is our mortgage, but when we did have debt we threw as much as we could at it to get it paid off faster.
Thank you John! Still needs a bit of work but I am getting there…
$150 for a refinance? I am jealous. Fees vary a lot in the US, and they are particularly high in our state. Our last refinance cost about $4.5K in fees – so it takes a pretty big change in rates to make those costs worthwhile.
that is quite expensive! A couple of month later, my bank had a 0 fee refinance offer, but no better rates than the one I got.
Great write up Pauline. I think you hit every point. I also hate debt and I think it is because I hate the idea of being a slave to someone (or something i.e. ‘bank’) else.
That being said, I do have some debt and am shooting for having it all paid off one day (including my house). I know that’s a long way off, but doesn’t stop me from making it a reality.
Also, nice work on the refinance. That’s an amazing deal at $150.
I was lucky to get such a good deal, if not it is hard to offset the cost with the interest reduction. It is great that you have goals to pay debt asap, with motivation it will be gone in no time.
I love it….”Bank of mum.”
I WOULD have done a similar strategy, but I have a brother that never repays loans to my parents. He’s made it impossible for my sister and I to ever borrow money because he has them overextended. It will probably end up the opposite: my mum signing up for the “Bank of Joe.”
what a shame that your brother didn’t reimburse your parents. I hope they didn’t give him too much as to put themselves in trouble. I have a AAA rating at the bank of mum’s 🙂
My wife and I refinanced our mortgage a few years ago and it was defintiely worth it. We owe less, nothing better than that! For any of these optoins, like you say, you’ve got to be careful. Do you research and figure otu what makes sense. Don’t be messing around with loans and debt becuase you want to buy a new Tablet or something — be smart!
If one person reads that and does smarter financial choices then it was a great day. With so much information available online we should be smart with our money.
When I was in debt I consolidated. I found it really helped me get a manageable payment plan that I could stick too. It didn’t take long for me to pay things off which was great.
I have had a few examples around me of longer terms and higher interest paid (not necessarily a higher rate, just because you pay for a longer time). Glad it worked for you.
I’ve reduced my debt payments so far by paying off the debt as fast as possible. I could do a balance transfer from my student loans to my line of credit, but it would only save 0.5% interest and it would tie up my line of credit.
I might also refinance the loan with through my employer at 0%, which would be amazing, but I haven’t figured out the details yet.
It is smart to keep your line of credit open, although the employer’s 0% sounds awesome! I guess you have to stay and work for them for a long time. I bought a bicycle trough a “cycle to work” scheme, my employer paid for the bike and it came out of my paycheck before tax (so 40% savings on the bike). But when I left them I had to pay all the remaining installments at once.
I pay it off quickly, to reduce its cost. I think you’re after examples that are more like our car. My car was written off, so we had a cheque from the insurance company. We bought a brand new car with financing. The rate on the new car was less than the mortgage, so we put 0% down and put all of the insurance money against the mortgage, saving ourselves the difference between the interest rates. We have a large car payment each month, but can easily cover it with cash flow and saved ourselves a chunk by doing something that appears to be bad (financing 100% of the price).
That is a great example of arbitrage, with a lower interest rate it makes complete sense to pay higher rates first.
Nice and thorough writeup, great job! I currently don’t have much debt but can appreciate the tip on borrowing from family. The only problem is, sometimes it’s the other way around when family asks to borrow from you and you don’t trust them with repayment. What do you do then?
I would take a guarantee from them, a written letter or an object. I know it’s not nice but it should help keep my sanity. If my sister is looking to borrow money, I would have a letter from her (if I didn’t trust her, which I do) saying I get a bigger % of our inheritance maybe?
I too think the arrangement you have with your mother on borrowing money is a very good one. Not many families can do that and be so specific about the arrangement.
PS – If you changed themes it looks strange on Firefox browser. Not sure why.
I am lucky to have her! Yes I changed my theme and I use Chrome but will have a look in Firefox… just when I thought is was finally ok! thanks for pointing that out.
CC transfers can be a great way to save money. As long as you know when your 0% interest rate is going to spike. Plus, it’s good to stop using the cards while you’re trying to get out of debt.
I have a reminder in my calendar just to make sure I am on time!
I will for peer-to peer lending options, most of the cases it will not charge you commission fee or charges not like other lending institutions or banks. What I like from peer-to-peer lending is that if you need cash they can provide you in instant or the loan process is faster than other lending companies.
I will go for peer-to peer lending options and most of the cases it will not charge you commission fee or charges not like other lending institutions or banks. What I like from peer-to-peer lending is that if you need cash they can provide you in instant or the loan process is faster than other lending companies.
I am not very familiar with peer to peer lending to be honest, I looked at it from a lender’s side and it looked nice, I plan on investing in it next year.
Great post. We are debt free except for our mortgage, and it’s an awesome feeling. We’re paying our mortgage off ridiculously fast. We’re reducing it by about 5% of the outstanding balance per month. Yay for speed repayment.
Amazing! Yay for lightspeed payment!
I have looked into the whole peer to peer lending thing and it just all looks a little bit risky for me (at least as a lender). I guess that’s why you pay a premium.
Liking the theme Pauline!
From what I understand you can lend $5 to 100 different people, spreading your risk. They have an average default rate that is taken into account when calculating potential returns. If you take the riskier profiles, you can indeed lose it all.
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