<< Pay Off Debts More Quickly Checklist

Well done!

If you have multiple “other” debts, use the notes section to make note of the ones you paid off completely and what is still outstanding. When you’ve completed paying off all your “other” debts, check this task off the list! Well done!

<< Pay Off Debts More Quickly Checklist

Add An Extra Payment

Go to your lender’s website and make the necessary changes (either increasing your payment or setting up a secondary payment). In some cases – often with a mortgage for example – the website will give you the option to add an “extra principal” payment.

<< Pay Off Debts More Quickly Checklist

Setup a New Payment or Add to an Old One

This will either be a single payment that is larger than your existing payment or a secondary payment that adds to the total you pay each month. If you’re not sure how much you can afford to make, use your MoneySwell Budget Planner tool.

Complete the Tasks

If you’ve determined you will pay off your “other” debts more quickly, you need to make the adjustments to your regular payments (either by modifying an existing one or setting up a secondary payment for the extra amount). Complete each subtask before marking this task complete.

Subtasks

1. Determine Extra Payment Amount(s)
2. Make Update with Lender(s)
3. Mark All Debts Paid Off

Time to Get To It

At this point, you’ve done the math. You calculated the financial impact of paying down debt more quickly vs. investing your extra cash.

Additionally, you’ve considered your own psychology. You’ve asked yourself if you would prefer to guarantee paying less money in interest vs. the potential larger growth of investments.

Based on both financial and psychological factors, you’ve made a decision and now it’s time to act. Follow the steps in the “Pay off Debts More Quickly” checklist, or follow the steps in the “Make Additional Investments” checklist. If you want, you can split your extra cash between paying down debt faster and investing to get a little benefit from both.

Start With the Numbers, Then Consider Your Mindset

There may be psychological factors that determine if you invest extra money you have or pay off debt faster. But knowing the difference based purely on numbers should guide your thinking as well. Follow the steps below to understand the impact.

1. Calculate the Total You Would Save in Interest Payments:

1. 1. Use this loan calculator from Bankrate.com and note the “Total Interest Paid” calculation. To use the calculator you’ll need to know your current total balance, the remaining number of months on the loan, and your annual interest rate (i.e. your APR).
   2. Now click “Add Extra Payments” and enter the monthly extra payments you plan to apply (or enter the one time payment amount). Make a note of the new “Total Interest Paid” calculation.
   3. Subtract the original “Total Interest Paid” from the new “Total Interest Paid.” This represents the total amount you will save by applying extra payments to your loan. 
   4. Note this final number as your “Interest Savings” number.

2. Calculate Your Possible Investment Earnings:

1. 1. Use this compound interest calculator from Investor.gov.
   2. Enter “$0” in the initial investment field (unless you have a one time payment you are planning to apply to your debt or invest).
   3. In the “Length of Time in Years” field enter the loan term. 
   4. In the “Interest Rate” field enter your expected annualized rate of return. We suggest 7%.
      
      (Remember the while the average long-term annualized rate of return for the S&P 500 Index fund is between 10 and 11%, there is huge variability year to year. The shorter the time horizon, the lower your confidence should be in any particular rate of return. Additionally, after inflation, some have calculated the average rate of return closer to 7.5%. To keep things simple and conservative, if you have a time horizon of at least five years, use 7% but know that your actual return may be better or worse.)
   5. Click “Calculate.”
   6. Hover over the graph and subtract the difference between your total contributions and the future value. This represents your possible total investment earnings. 
   7. Note this final number as your “Possible Investment Earnings” number.

3. Subtract the Difference Between Interest Savings & Investment Earnings

1. 1. Take the final number from step one and subtract it from the final number in step two. This number represents the amount you would benefit by investing vs. paying off debt at respective interest rates.

A Note on Taxes

If your earnings will be subject to Federal income tax, you can subtract an additional 10 – 37% – based on your effective tax bracket – from your earnings number. This will give you a closer estimate of the true value of your investment earnings number. To find out what your marginal tax bracket is, search the web for “marginal tax rates” and compare that to your income. You can also search for your state tax rates too if you want to get even more precise.

If you choose to go the route of paying off debt early, whatever you save on interest by paying off early will never be taxable so you don’t need to worry about this.

Details

Reaching financial independence (the goal of this tier) doesn’t mean you have to pay off all your debt. But if you have interest-bearing debt, it is costing you whatever you pay in interest. If you have no-interest or unofficial debt, it will weigh on your mind if nothing else. While it’s worth considering opportunity costs with other investment options (your next step), tackling your final pieces of outstanding debt as you strive for financial independence is a solid goal.

Low-interest Debt

• Any debt below 4% interest will generally be considered “low-interest.” When determining if you should pay this off faster than required, it’s important to consider what else you could do with that money. For example, by investing in a broad market index (like the S&P 500), over longer periods of time you’re likely to make substantially more money than you would save in interest payments. (See the Payoff vs. Invest Calculation example in the next task.) According to Investopedia, the average S&P 500 return for any 10 year period is 10.13%. And this article from The Balance highlights that the worst rolling 10-year period ever saw an average annualized return of -4.95% (the best 10-year period was 21.4%). While a negative return isn’t good, by definition, the “worst” period doesn’t happen very often. And if you stretch out the investing period to 15 years, the worst period was a positive return of 4.24% (the best 15-year period showed an 18.93% annualized return), and for a 20-year rolling period, the worst was a positive 5.62% annualized return (and the best 20-year return was 17.88%). Therefore, if you have a longer time horizon and are willing to ride the ups and downs of a broader stock market index like the S&P 500, your investing returns would likely be more than your debt interest payments. Put simply, from a purely financial perspective it may be better to invest your money than pay off low-interest debt as quickly as you can.From a psychological perspective however, there’s nothing wrong with eliminating debt more quickly. This is particularly true if it gives you a sense of security and you like the guaranteed savings of paying your debt down faster.

Medical Debt

Medical debt typically has no interest or very low interest. If you have acquired medical debt, you can often negotiate directly with the provider to create a payment plan to pay this debt off over a set time period. In some cases, you may even be able to reduce the total amount you owe.

Family or Friend Debt

If you have any debt owed to family or friends, whether it’s interest-bearing or not, at this stage in your financial journey it’s time to focus on paying it off. It’s simply not worth hurting your relationships by extending the payback period any more than you absolutely need to.

Specifically, we recommend taking the following steps:

• • Get in Touch: Reach out and say you’re ready to pay them back. If you can’t do it in a lump sum, let them know what you think you can afford and on what schedule. Ask them if they expect any interest in return for their previous generosity.
  • Put it in Writing: If you’re making a lump sum payment, send an email (or something more official if you prefer) indicating you have paid them back, the date you did so, and any other details regarding the purpose of the original loan.If you are planning to pay them back over time, write down the following:
    • The regular amount to pay
    • The frequency of payment
    • The expected final payment date
    • The shared location where completed payments can be referenced (e.g. an email thread, a shared spreadsheet etc.)
    • The link to the loan calculator you used to calculate interest (if applicable)
      
  • Celebrate Together: Ideally, you will have an agreement in place that both parties are comfortable with and when you make that final payment, you’ll both feel a sense of finality and can celebrate together.

Details

High-interest debt sucks. There are times when you may have no other option and having some form of credit or loan available that is high-interest can help you get out of a bind. But make no mistake; if it helps, it only does so at a very high cost. Your goal is to understand how it works, pay off what you have, and if at all possible, not acquire it moving forward.

Definition

High-interest debt refers to the interest rate charged to borrow money. Typically “high-interest” is anything at 10% annual percentage rate (APR) or higher.

Example: If I lend you $100 with a 10% interest rate and the interest compounds (charges interest on the interest) only once annually, if you pay me back within a year you’ll owe me: $110 (which is the principal you borrowed + 10% of that principal).

Common Examples of High-interest Debt & Corresponding Interest Rates

APR vs. APY: Sometimes you’ll see “APY” emphasized instead of “APR.” APY stands for “Annual Percentage Yield” and is a reflection of the fact that the frequency with which interest compounds can affect the total amount of interest owed over a given time. All you really need to know is that most high-interest debt compounds daily which means your APY will be a little bit higher than the APR. This calculator shows it clearly.

How High-interest Debt is Acquired

Credit Cards: The most common type of high-interest debt comes from credit cards.  If you use a credit card but pay the full balance before the statement due date (usually 21 – 30 days following the date you receive your statement), no true debt is acquired and no interest will be owed.

But the Federal Reserve has estimated that the average credit card debt of U.S. families is $6,270. In every circumstance, this debt came about because something less than the full statement balance was paid. So while you are only required to pay the “minimum monthly payment” as shown on your statement, if you do so you will be acquiring high-interest debt. Whenever you can, pay the full balance on your credit card statement.

Auto, Personal, & Private Student Loans: When you purchase a car with an auto loan, take out a personal loan, or private student loans, you are taking on debt. If you have less than stellar credit, it’s possible these loans will have interest rates which would qualify as “high-interest.”

If you already have high-interest debt, it’s important to ask yourself why. This isn’t about blame. But it is about being honest with yourself and understanding what got you here. Which statements below resonate with you?

• “My spending is for genuine needs and is reasonable. Unfortunately I don’t earn enough income and need to focus on making more money.”

• “I earn solid income but I almost never have enough to pay all my bills in full. It might be possible for me to reduce my expenses or purchase lower-cost items in the future.”

• “I have acquired high-interest debt but it’s for a genuine investment in my future. The extra cost is worth it to me and I won’t regret it in the end.”

In all likelihood, all three statements likely resonate to some degree. But only by being honest with yourself can you be at peace with where you are today, and create an effective plan for improving your debt situation moving forward. 

Why High-interest Debt is So Dangerous

Regardless of why you have high-interest debt or what was acquired with it, the following remain true:

• You’re paying extra: Everything bought on high-interest debt now costs you the original price, plus the total amount of interest you end up paying. If you want to improve your financial health, you can’t afford to pay extra. The sooner you break this cycle the better off you’ll be.

• Someone is making money off of you: There are many valid reasons for companies to lend money. And these companies don’t have to be corrupt or nefarious to do so. But you can’t forget that the longer you are indebted to them, the more money they make off of you. In this sense, your incentives and theirs are not aligned. Therefore you need to be clued into how you acquired your debt and your plan to pay it off. The best person to look out for you…is you.
  
  And remember: Credit card “rewards” make no sense if you’re paying interest on your debt. Even a great (and probably temporary or category-restricted) 5% “cash back” offer (and most are more like 1-2%) is completely useless if you’re paying 20% in interest. Don’t be fooled.

• The debt can snowball: If you find yourself in a situation where you are purchasing items with high interest debt that you want – but don’t need – (this could be clothing, a fancy car, travel, dining out etc.), you will not only have to pay extra for the things you bought, you will also have to break the habit that got you there in the first place. If you can’t really afford that $300 jacket today, do you really believe you’ll be able to afford it at $350 several months from now (which could be what you’ll pay when you factor in interest)? 

As more of your money gets consumed by interest payments for items bought yesterday, last week, and last month, you have less available to spend on the things you need today, this week, and this month.

Put another way, if you use high-interest debt to pay for things you want now, you may soon find you’re using high-interest debt to purchase things you truly need later. And this can become truly challenging to overcome.

Calculate Your Debt Payments

To get a clear picture of how much your high-interest debt may cost you as you pay it down, you can use Bankrate’s debt paydown calculator. Regardless of the type of debt you have, you’ll need three pieces of information, all of which should be available on your most recent statement:

• Interest rate – the rate they’re charging you (remember sometimes this will be constant and sometimes it will be variable depending on the loan or conditions of the line of credit)
• Current balance – i.e. the total amount you currently owe 
• Minimum monthly payment – the smallest amount the lender is requiring you to pay each month

Many Have Conquered Their High-interest Debt. So Can You.

High-interest debt can feel completely overwhelming. But there are plenty of ways to lower the debt, strategies to help pay it off faster, and eventually rid yourself of it completely. We’ll tackle these in upcoming tasks. But just know that if you have high-interest debt, you’re not the first and you won’t be the last. If you imagine what it will feel like the day you become debt-free, and follow your plan to get there, it will happen. 

You’ve got this!

Set Up From a Lender or a Bank

Do either of the methods described in the Quick Look section above set up an automatic payment. This automation will make it easier to make progress toward paying off your debt. Here are a few tips to optimize this process.

Tips for Your Automatic Debt Payoff

• Time Your Payment: Make your payment at a time of the month that works well for you. You’ll get your statement at the same time each month but there will be a window between the statement arrival date and the payment due date, sometimes up to a month. And you can set up your automatic payment for any time in that payment window.Consider setting your payment to come immediately after you get a paycheck, or in the middle of the month when you don’t have other bills to pay. Whatever time you set just make sure it works for you.

• Make Your Payment Round: By this we mean, if your monthly payment is supposed to be $237.45, consider rounding that number up to $250 or even $300 if you can. Not only will this small round up mean you’ll pay off your debt a little faster, it will also be easier to mentally calculate how you’re tracking on your monthly goals or whether or not you’ll have enough in your account to pay the amount due on the required date. When it comes to personal finance, simple math is almost always better.

• Student Loan Pro Tip: If you set up an automatic payment for your student loan, many lenders will actually reduce your interest rate by 0.25% just for setting that up. This means more of your money can go toward paying down the principle you borrowed instead of paying interest to the lender. Even if your lender doesn’t advertise this benefit, call them an ask anyway! Simply say, “I’ve heard that some lenders will reduce the interest rate if I set up an automatic payment. Is this something you do too?”

Set That Date

Research shows that when you set a date for achieving a goal, you are more likely to do it. In fact, in the SMART goals framework, the “T” stands for “Timely.” Therefore when it comes to your debt, you want to know precisely when you’re going to pay it off.

When you calculate your debt payoff dates, you may have one of two reactions (and both can be useful).

1. Pleasantly Surprised: Because debt can feel overwhelming, it’s not uncommon to ignore it and just pay whatever you have to, and slowly chip away at it (this can be particularly true if you haven’t consolidated your debts). But when you take the time to calculate when you’ll actually be done paying it off, something that once felt like it was going to take forever, may now feel like it’s within your grasp to pay off in the near future.
   
   If you find yourself in this position, you may be motivated to up your payments or, if possible, make a one time lump sum payment to be rid of it entirely. At the very least, you should feel a sense of satisfaction for seeing how far you’ve come.
2. Scarily Shocked: If you find yourself feeling this way after you’ve calculated your payoff dates, take a moment and remember this: Many have been in your exact position before and come out the other side. You too can get there. Additionally, you’re already taking the first and most difficult step: you’re facing your challenge head on.

If you find yourself in this position, use the MoneySwell Budget Planner tool to figure out what changes you may be able to make to your income or spending so you can pay your debt off faster. (Consider adding a row within the “Spending” category for your debt minimum payments. Then, add a row in the “Savings” category that represents extra debt payments.)

Action

In the notes section above, write down your:

• Original debt payoff dates before any adjustments you may make
• Planned debt payoff dates after adjustments you may make
• Actual debt payoff dates once you’ve done it

Believe it or not, research shows that taking small steps like those listed above can make a big difference in ensuring you achieve your goals.