Wednesday, March 26, 2014

Interest vs. Principal

As we get closer to the end of the month, Nick and I also get closer to making our first extra payment towards our debt. I think that we have a good game plan, but I have been reading up on debt elimination to make sure that I cover any "blind spots." If you watch House of Cards you will get this reference :)

I am not looking for a brand new system, but to figure out the best practices to eliminate our debt in the least amount of time. For example, I already learned about adding in short-term costs that should be accounted for in our budget monthly to help us take care of planned life expenses. Example: put $10 aside each month for an oil change so every three months you don't have to find $30 in your budget to take care of this necessity.

About three weeks ago, I went to the library and borrowed Dave Ramsey's The Total Money Makeover: A Proven Plan for Financial Fitness. It was perfect timing to get through Chapter 7 on Snowballing your debt the week we were going to make our first extra payment to debt. I will be sure to do additional write-ups on his book as we get further in the process.

Taken from www.daveramsey.com
The general idea behind Snowballing your debt is to pay off your debts by the principal balance, low to high. This will allow you to accumulate additional funds as you pay off your debt to put towards the next highest amount. Dave uses an analogy of a snowball rolling down the hill collecting snow, just like your money will roll down the debt list collecting minimum payments as it goes. The motivation behind paying by principal is to allow you to have some quick wins on your smaller debts and to keep you motivated in your payment plan.

However, I struggle with the idea that in the mean time our higher interest rate loans will keep going up and we will owe more money on these loans in the long-run.

In looking through a list of our student loans, I organized them by principal and then by interest. I think we may be able to achieve some quick wins to keep us motivated and some high interest payments by working with a hybrid plan. In order to pay off the higher interest rate loans, we can pull a few of them higher in our payment plan list. I believe this will help us stay motivated, but also stop us from paying more interest then necessary on some of our loans. A compromise is in the works!


Question of the Day: How do you prioritize repayment of your debt, by interest rate or by principal? 


5 comments:

  1. learned alot from your blog and will try implementing some of the ideas into my own budget and life goals. keep writing! Will recommend your site to others especially those leaving college with new finaincial debt.

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    1. Thanks Olga! It is hard for college grads to see around this mountain of debt to a future without student loan payments. After graduation you are given 6 months to get settled and then the bills arrive, usually with 30 days’ notice, and the amount is always a bit daunting. I looked at a loan last night for an original amount of $1,000- my principal balance after 5 years is $934, meaning all my payments have been going to interest. Like any debt, try to pay more than the minimum balance whenever possible and be sure that it is applied to the principal amount. Sometimes you need to call the loan company to verify that it’s applied appropriately.

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  2. Good luck getting out of debt! I am writing an article about the debt snowball method and would like to feature somebody like you. If you are interested let me know.

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    1. Thanks for your comment. I would love to follow-up with you on our current experience with the snowball method.

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