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Look – debt is nasty stuff.  After the ‘shine’ wears off of the stuff you bought – the payments linger and begin to smell – bad – really bad. 

Debt is a financial drag.  It shifts priorities away from the things that are most important (like our families) – to things that are completely unimportant (like our banker’s family).  It creates emotional stress.  And in many cases – it causes relationship problems – or worse.

But there’s a bit of a silver lining when it comes to debt.  You have far more control over both the timeline and the cost of borrowing than you may think.  You see – the ‘cost’ of debt is a mathematical formula that requires three variables.

  • The amount borrowed/amount of the purchase,
  • The Interest Rate charged by the lender/creditor, and
  • The amount of time over which you’ve agreed to repay the ‘loan’

These are the ‘terms’ of the loan – and when put into an amortization calculation, they determine the minimum monthly payment for an amount borrowed. 

If we borrow $10,000 at a 5% interest rate, and pledge to repay the loan over 5 years, the payment will be $188.71.  It will be $188.71 no matter who the bank or lender is – because the amortization calculation is universal. 

A couple of quick side notes.  A credit card lender will not use an amortization calculation because it is an open line of credit.  Typically, the minimum payment will be a percentage of the outstanding balance, plus interest charges for the period.  Home equity lines of credit also dispense with the amortization calculation.  They typically charge interest only, and do not reduce the outstanding principal balance at all. 

In this example, if you make those 60 payments (5-years) of $188.71, the total amount repaid will be $11,322.74 – meaning the interest portion (cost of borrowing) would be $1,322.74. 

Here’s the secret that gives you some control over the ultimate cost of borrowing – and the time you’ll be in debt.  Of the three variables – you have no control over two of them (the interest rate and the amount borrowed), but you do have control over the repayment time.

The 5-year term is the MAXIMUM time over which you may repay the loan – not the MINIMUM (unless there is a pre-payment penalty).  If you hit the lottery the day after taking the loan – you could repay the principal in full – and incur NO interest charges at all – and be out of debt instantly. 

You see – even though the lender controls two of the variables (rate and amount borrowed), the one that remains in our control (time) has the power to override the other two. 

This may not seem very exciting if you don’t have the means to repay the loan in a shorter time, but it should.  That’s because you don’t have to hit the lottery to achieve a better outcome.  Adding just a few dollars each month to the required minimum payment, will save you money (interest); time (  you’ll be debt-free sooner), and you’ll get a monthly pay raise when that payment goes away sooner than it would left to the lender’s repayment schedule. 

Revisiting our $10,000 loan example, what if – instead of paying the required minimum payment of $188.71 each month – we could increase that by $20 to $208.71?  Three important things happen. 

  • First, you’ll pay off the loan in 54 months – buying yourself a full 6 extra months of debt-freedom, 
  • Second, you’ll save $145.31 in interest – money you don’t have to pay the lender, and
  • Third, beginning in month 55 – you’ll get a $188.71/month ‘pay raise’ because the loan will have been extinguished.  That means you will have enjoyed an additional $1,132.26 to spend on other financial priorities ($188.71 X 6). 

Now to be clear, you did ‘spend’ an extra $1,080 ($20/month for 54 months) to make all this happen.  So – was it worth it?  Let’s look. 

Emotionally, your mental health got a big boost by cutting 6-months off the payment schedule.  That 6-extra months of debt-freedom is a big deal to most people who had resigned themselves to the idea of having a full 5-years of payments (in this example).

Financially, you turned your $1,080 ‘investment’ in extra payments, into $1,277.57 back in your pocket ($1132.26 in ‘pay-raises’ and $145.31 in interest savings).  Turning $1,080 into $1,277.57 in 6-months, is like earning a 7.4% return on your money.  By the way – that 7.4% return is both risk free (not a market-based investment), and tax-free (no taxation on ‘saved’ money).  Not too bad.

Finding $20 a month today might seem like a sacrificial challenge, but consider this: if you could pay another smaller debt off and use the freed-up payment from it to get after the next debt – it would not need to be sacrificial at all – and you would be embarking on a pattern that could accelerate the repayment of all your debts – and save you ton’s more money in the process.

Whether you can start today – or 6-months from now; whether you can scrape together an extra $20 or $200 – remember that YOU control that one little variable upon which the entire timeline and cost equation relies. 

You have the control.  Use it to your advantage.