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Many of us feel a sense of anxious urgency about our prepping. We know that if we suddenly find ourselves trapped in a Level 2 or 3 situation, we are not yet ready to be able to survive such a challenge; but what we don’t know is if/when a Level 2/3 situation might suddenly appear.
To put it as bluntly as possible, the biggest constraint we have is the lack of cash to invest in our preparing.
So what is the first thing you should pay off? Generally it will be the balance with the highest interest rate. Look at all the debts you have, and understand what the APR is on each of them. You might be amazed to see the difference in APRs. For example, maybe you have a discounted car loan at 1.9%, a student loan at 5%, a revolving line of credit at 7%, and two credit card debts, one at 15% and one at 24%.
In such a case, you should make nothing more than the minimum payments due on everything except the 24% credit card debt, and you should do all you can to get that 24% balance reduced down. At 24%, you are paying $20 a month on every $1000 you owe; if you can reduce the total owed by an extra $100 in payment this month, then next month that will give you a $2 reduction in interest you pay on the now lower total amount outstanding. $2 might not sound like much after having paid off $100 extra the previous month, but if you are making payments over, maybe, two years, then in approximate terms, that $2 is a recurring benefit over the 24 months of the loan and will (sort of) save you $48 over the remaining period of the loan. That’s a much more significant saving, isn’t it.
That is one of the key things about reducing your interest payments. A trivial seeming $1 a month reduction in interest payments might seem of no value at all, but it is saving you $1 a month for every subsequent month, as long as the loan remains open, and over many years, that really adds up.
The other key thing is that if your interest bill is now lowered by $1, next month your payment is going more to paying off the balance and less to paying interest, so you are paying off more principal, which means that the following month, there will be even less interest to pay and even more principle paid off, and so on.
You might already know that if you start missing payments, your debts start to spiral out of control. The flip-side of that is that if you start paying more than your minimums each month, you quickly start to reduce your balances much more positively than you’d have thought possible.
After you’ve paid off the worst loan (in terms of interest rates) you’ll then successively move through everything else you owe money on.
Generally, the last thing to pay off would be your house mortgage, because that probably has the lowest interest rate associated with it. Plus, for most of us, the interest is tax-deductible, reducing the real interest cost by as much as 30% or more (depending on whatever your top marginal tax rate is).
There’s no better way to control your outgoings without making any impacts on your lifestyle at all than by simply prioritizing how you pay off your debt, starting with the highest interest bearing debts first, and then working successively down to lower and lower interest bearing debts.
Some types of loan might have prepayment penalties associated with them.
Make sure that the loans you are focused on paying off as quickly as possible have no prepayment penalties associated with them. If there are penalties, you are probably advised to concentrate on paying off other debts first.
Many credit cards have a deal whereby if you pay off your balance completely when it is due, then each month’s charges don’t incur any interest if you keep paying them off when the balance comes due. Okay, we probably understand that already.
But did you know that if you don’t pay off your card entirely, then all charges immediately start accruing interest without the grace period you’d otherwise get if you were clearing the balance each month?
In other words, if you have to keep some balance on a credit card, have two credit cards. One which you are paying off, but on which you add no new charges, and a second one which you keep current, so when you add new charges to it, you can pay them off when they come due, next month, without incurring any fees on those.
If you can, it is very helpful to consolidate your debts and to move them to the lowest cost source of money.
For some of us, this can best be done by getting a Home Equity Line of Credit (HELOC). You’ll probably get an interest rate around 4% – 5%, and possibly might even be able to claim the interest as a mortgage/tax deduction on your 1040, depending on your circumstances and the nature of the amounts owed.
Let’s say you owe $5,000 at 12% and $5,000 at 18%, and you manage to get this transferred to a HELOC at 6%. That means your monthly interest payment will instantly reduce by $75 every month – more if you can make your new interest payments tax-deductible. That’s another $75 a month that you’ve suddenly created – and it is money you should then use to keep paying down your debt, at a new faster rate.
If you can’t get a HELOC, maybe you can still get some smaller loan from your bank or credit union, and if not at 6%, definitely still at much less than what you’re paying to the worst of the credit card and other lending sources.
Move the money you owe to the lowest cost lender.
We just spoke about rolling credit card balances to a HELOC. But what if you have a home mortgage with a high interest rate on it? Why not ‘kill two birds with one stone’ – refinance your home to a lower rate and also increase the amount you’ve borrowed to pay off other debt.
At the time of writing, there’s even a federal scheme that allows some home borrowers to get a federally subsidized new home loan with no origination fees and no qualification requirements. Ask if you qualify for one of those.
Maybe you sometimes get offers in the mail giving you ‘pre-approved’ credit cards and allowing you to roll over a balance from another credit card, with an initial grace period of no interest charge applying.
Make sure there truly are no charges – no ‘cash advance’ type charges or anything else at all, and if it truly is a way of getting some months of free interest, then if the interest rate that commences at the end of the free period isn’t worse than what you’re paying now, why not cut up one credit card and start using the ‘free money’ offer on the new credit card?
We know some people who have done this repeatedly, each time getting a new grace period of some months before any interest starts being charged.
Needless to say, don’t go into debt initially with the plan to do this into the future, but if you are already in debt, this might help reduce the cost of paying off the money you owe.
You mightn’t realize this, but many times you’ll find you are able to negotiate the interest rate you are charged on your credit card balances. The credit card company doesn’t just have one interest rate that everyone, everywhere in the US, uniformly pays. It sets interest rates more or less individually, based on your credit score, your history with the card issuer, your address, and many other factors.
If you have been making your payments regularly – or sometimes even if you haven’t – you might be able to negotiate a lower interest rate. Even if you only get a 1% reduction in your interest rate, this could save you thousands of dollars. Look at our table of interest costs in the middle of the previous article in this series, Seven Thoughts About Borrowing Money. Say you had a $10,000 loan at 18% and were making payments over a 10 year period. If you can reduce that to 17%, and if you keep your monthly payment much the same as it was before, that means you now pay your loan off over nine years instead of ten, and your total interest paid drops from $11,922 to $9,587.
You pay your debt off a year sooner, and you save yourself $2335 in interest, all as a result of getting ‘only’ a ‘small’ one percent reduction in interest charged.
That’s sure worth making a phone call and asking for, isn’t it!
Why would a credit card company/bank drop your interest rate? Because it costs them a lot of money to get a new customer; and it costs them much less to keep you as a good customer than it does to lose you and buy in another customer – the marketing cost of getting each customer, and the promotional cost of a ‘no fee for the first year’ and/or a ’100,000 mile frequent flier bonus if your sign up for our card’ and/or a ‘no interest on balances rolled over for six months’ or whatever other offer they are giving to new customers is massive.
There are sometimes good reasons and sometimes unavoidable reasons to go into debt (we discuss them here). But there are almost never valid reasons to delay paying off the debt you’ve incurred. The most compelling reason of all is that getting out of debt is just plain smart – your disposable income will skyrocket when you no longer have so much of your paycheck already committed to debt repayments.
The six steps above will help speed you towards a debt free future. It will help, but you’ve still got to do some heavy lifting too – make paying off your debt a priority, and accept some lifestyle sacrifices while doing so. In return, you’ll have a much healthier financial future.