Investing in Debt

Eric • 22nd Sep 2005 • Uncategorized

I went to a class last night that was focused on eliminating consumer debt, starting with credit cards, then working through student loans, mortgages, etc. For $27 ($18 course fee and $9 for the workbook), I got a lot out of the 3 hour class. I wish classes like this were built into our taxes, so more people would take them since they’re already paying for them… anyways….

The class basically goes through a method of prioritizing your debt and paying things off one at a time. Simplified:

Debt A has a $500 balance and a $15 monthly minimum (let’s assume 12.9% APR)
Debt B has a $4000 balance and a $85 monthly minimum (let’s assume 16.4% APR)

Your monthly minimum is $100, but you pay $120 as follows: $25 to Debt A and $95 to Debt B (share the love). The *right* way to tackle this is to pay $35 to Debt A and the minimum to Debt B. Then….

Debt A, instead of taking 43 payments, will take 17 payments
Debt B’s minimum payments are made for 17 months, then the $35 that you were paying to Debt A is rolled into Debt B’s payment – the whole $120 goes towards Debt B. Instead of taking 77 payments (at the minimum), it’s done in 46 (roughly)

If you paid only minimums, you’d take 6 years, 5 months. This method reduces your sentence to only 5 years, 3 months. You saved yourself $1,680 in debt payments. You also have an extra $120 a month now. This is a simplified example. In the real world (heck – take my world) there are 3 credit card balances, 2 student loans, a car payment, and two mortgages (luckily, on two different properties). When this debt is paid, the debt payments are now money in my pocket!

That’s with an extra $20 payment. The system encourages you to shoot for 10% of your monthly income. Start with this – if you’re investing in your 401(k), an IRA, whatever – STOP. Your credit cards cost you what… 14, 15, 18, 22%? Are you getting a 22% return on your IRA? Probably not. Invest in your DEBT now, and in your future later. Where else can you find this money? I’ve heard it referred to as “The Latte Factor”. A $3 cup of coffee from StarBucks (that’s a small, right?) 5 days a week = $60 / month you could put to your payments (BTW – $60 extra eliminates those theoretical debts in 40 months, or under 3-1/2 years).

Still reading? Good (gee, I feel like Steve writing something so long).

So how do you know what to payoff first? How do you know when you would be out of debt with the “share the love” method of payment, and when you’ll be out with this new payment? Use the “Debt Eraser Software” – “Eric, where can I get this great software???” The
Invest In Your Debt Webite! But the general rule is start with the smallest balance – even if there are balances with higher interest rates? The difference in the payoff schedule is miniscule, but the emotional freedom and reward you’ll feel when you have a debt paid off is huge.

Another topic touched on was how to reduce spending – the Spend Smart method. This was only touched on, as there’s another course on how to spend less money. Some points are ridiculous… save a nickel here, a penny there… but some are worth reading, like how to get better insurance rates, and where to shop for the same stuff, only cheaper.

As you can probably tell, I’m excited about this – sounds like step 1 on a long and profitable journey.