How to Pay Off Debt Quicker, Guaranteed
My last financial article, Stoozing…How to Have a Credit Card Make YOU Money, seemed to get a lot of attention so I decided to delve into another money making tip this week. It’s actually a money saving tip, but if you invest that money you save, it will turn into a money maker. You can see I’m trying to change your thinking! It is something simple and easy to do, only requiring a little discipline and maybe an extra postage stamp each month.
How would you like to pay off that 30 year mortgage in 24 years? How about paying off that new car loan a few months sooner? We could all use that, and I will show you how.
This method will work on any debt you have, be it mortgages, credit cards, car payments, student loans, etc., regardless of whether they use a simple interest or a compound interest formula. Let’s get started!
Instead of letting that due date creep up on you and sending your bill payment at the last minute each month, pay half the payment every two weeks. By doing this you will drastically reduce the interest you pay over time because you will be cutting into the amount outstanding by month’s end, thereby reducing the amount of interest you pay on the balance. It will even help you organize your finances more efficiently if you get paid bi-weekly (as most of us do these days). It’s that simple! In case you missed it let me break it down (without too much math).
We are using a simple interest formula for this example.
Let’s say you have a debt of $20,000 on that new car you just bought. We will also say you got a pretty standard interest rate of 7%, and a payment of $350 per month due on the 30th of the month. All relatively standard figures. By the time your first payment is due you will now owe $20,116.67. That’s because the interest for that first month was $116.67. You make your first payment of $350 at the end of the month and you now owe $19,766.67. By the time your next payment is due you will have accrued another $115.30 in interest, increasing the amount outstanding to $19,881.30. After your next payment of $350, you now owe $19,531.30 at the start of the 3rd month. Not bad, but we can do better.
The calculation for interest here was Balance x 7% / 12. We divide by 12 because there are 12 months in the year.
Now let’s look it at making that same $350 payment bi-weekly. We will pay $175 every two weeks instead. If we pay the first payment of $175 on the 14th we will have accrued a little less than half the interest for the month, $53.85, for a total amount outstanding after payment of $19,878.85. Another 14 days go by and you make your next payment of $175 on the 28th. In those 14 days you’ve accrued $53.52 in interest, payed $175, for a total amount outstanding of $19,757.37. 14 days later we add $53.20 in interest and subtract our $175 and come to a figure of $19,635.57. Another 14 days go by we make our $175 payment with 52.86, and after two months we owe an outstanding balance of $19,513.43. We just saved $17.87 in those two months worth of payments (and we’re still a few days early).
The calculation for interest here was Balance x 7% / 26. We divide by 26 because there are 26 two-week periods in the year.
The reason this method works is because we end up making 26 half-payments each year, rather than 12 full payments. It’s that difference of being able to divide by 26 that saves us the money. Not only will we save on interest costs, but we will in-effect end up paying one extra payment each year, further reducing the balance subject to interest. Furthermore, we will reduce the amount of time it takes to pay off our loan. AND it actually makes budgeting expenses SO much easier because most of us are paid bi-weekly!
It’s that simple! As you do the math, this effect snowballs. Over time it will save you a lot of money. You can do the rest of the math and see how much it will save you in the long run, especially if you have a mortgage payment or a lot of debt. Using this method with a mortgage will save a considerable amount, 50k or more on 200k loan, and take years off the loan. Also, we used a low interest rate. If your credit is not so hot and you have high interest debt, you will end up saving MUCH more while paying it back in less time.
And of course, paying online is in most cases free, and will save you that 41 cent stamp we talked about.
Interest kills. Paying bi-monthly will save you a bundle long term.
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3 responses so far ↓
1 rhart23 // Nov 10, 2007 at 12:00 am
So I am assuming that if I decide to make a payment every week I would benefit even more right? With online bill pay and recurring payments its really no extra work so why not?
2 G-man // Nov 10, 2007 at 12:46 pm
You are indeed right. The reason I laid out the every two week plan was because it works well with most people’s paycheck schedules, but every week would work too.
3 somnief // Mar 3, 2008 at 9:25 pm
Preface: I am not going to say that this is a bad idea.
While this payment plan may work on the others, it won’t work so well with your car payments. When you take a loan out for a car, they take the principle amount and plug it into their table which automatically calculates how much you would owe in total – including the interest – and then calculate your monthly payment from that. If you were to send in (half) your money two weeks early, the next bill you get will indicate that you owe less than what you usually owe. The same goes for if you were to send in $1100 on your car payment of $350 – for the next 3 months, they are going to send you a bill for $0.00 so you don’t get ahead on your payments (aka, less interest for them).
However, if you were to just send them half your monthly payment every two weeks regardless of what they bill you for – this method will save you money.
Just a clarification-
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