Reduce Personal Debt before It Bleeds You Dry

If you wait to reduce personal debt, the waiting period will increase your cost. Many borrowers do not understand the long-term financial implications of debts that are not immediately repaid. Personal debts tend to have the highest fees and rates, so the implications may be greatest on these debts. As a result, it is critical to keep your personal debts low in order to build a sound financial base. 

Personal Debt Example

You take a personal loan of $5,000 in 2010. The debt is offered with an APR of 7.5 percent. If it takes you five years to pay off the debt, you will owe monthly payments of $100.19. At the end of the five-year period, you will end up spending $1,011.38 in interest alone. The realized interest rate on the debt is over 20 percent.

Now, imagine you pay off the loan in three years instead. You increase your monthly payment by only about $55, the equivalent of one or two fewer restaurant dinners a month. In this scenario, your total interest is only $599.12, and your realized interest rate drops to 11 percent. Simply by allocating $55 more dollars a month to the loan, you have saved yourself nearly $500.

On the other end, if you take a seven-year loan, your interest payments increase to $1,442.08, with a realized interest of 28.8 percent. Each year you wait to repay a loan, you are allowing the lender to accumulate a much greater payment from you and digging yourself a bigger hole of debt.

Take Short Loans

The key to saving money on personal loans is taking the shortest loan possible. On a short loan, interest compounds fewer times. Lenders additionally assume less risk on a short loan. As a result, they will offer lower starting interest rates on the debt. You can avoid taking long loans by keeping your limits low and your monthly payments as high as feasible.

Budget Correctly

You may be attracted to "low monthly payment" options, but these options only cost you more over time. Instead, think about how much you can afford according to your budget. Your total monthly debts, including rent or mortgage, auto debts, student loans and other fixed payments, should never be more than 50 percent of your monthly income. When you decide how much you can pay to a new loan, use this formula. Determine the maximum amount you can afford to pay. It is wise to leave a little breathing room below this maximum. However, do not simply take low monthly payments to increase your spendable income monthly. You will find the cost of waiting to pay off the loan is not worth this decision. 

Repay Debts in Bulk 

When you receive a bulk sum, through a bonus, investment or other source, consider using the sum to pay down some or all of your debt. There may be penalties to repaying debts early. However, these penalties may actually be lower than interest rates in the long run. Talk to your lender about quotes to pay down your debt and determine how much you would truly save after any penalties. 


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