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Monday, May 20, 2019   
 

Paying off debt is hard work
by Scott Bilker
Scott Bilker is the author of the best-selling books, Talk Your Way Out of Credit Card Debt, Credit Card and Debt Management, and How to be more Credit Card and Debt Smart. He's also the founder of DebtSmart.com. More about and DebtSmart can be found in the online media kit.
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Scott Bilker

Scott,

Your advice on several topics lately has been about moving around debt to produce the lowest APR or the most savings to consumers. However, it does not cover anything about the hard work of actually paying off the debt. The point of this website should be to pay off your debt and not just pushing it around from one account to another.

For example, your most recent answer to a reader who wanted to charge a car purchase on a credit card was missing half of the answer. When you obtain a car loan, the loan is paid off within a period of time, say 5 years. This time period cannot be changed unless the entire loan is refinanced. This requires the buyer to pay an amount that covers interest and a significant portion of the principal. However, when you finance the purchase, say on a credit card, the payment period can be as short as 1 year or as long as 30 years. If you paid the minimum monthly payment on a credit card, you could easily pay more in interest than if you took out a car loan.

Example, if you took out a 5-year car loan for $15,000 at 6%, your total interest is $2,400. If you purchase the same car $15,000 at a special credit interest rate of 3%, but take twice as long to pay it off, it will cost you $2,402. It would be easy for someone to say, "Well, just pay it off early," but you and I know, that is easier said than done. And this is the point I want you to address in your future advice. Paying off debt is a psychological issue. The psychology of paying off your debt fast and using your credit to make money not spend it.

Joseph

Joseph,

Thanks for the feedback! You make a number of good points.

My vision of DebtSmart.com is not simply "paying off debt." That's a brute force approach. My approach is to be "debt smart." Smart in using one's credit to their advantage in paying off debt. Learning to take control of creditors instead of being controlled by banks.

One of the many lessons I learned in wrestling and karate is that technique trumps strength. For example, a smaller person, such as myself, must use the opponent's strength against them by redirecting their movement. Strength vs. strength when you are smaller is the path to defeat.

When you're getting charged 21% on your credit cards, you can pay-pay-pay, and get nowhere. Step one is to use the creditors' aggressiveness against them. Transferring balances to lower rates can do that. That's the technique. It's the first technique needed to fight the high cost of interest fees.

That's why I list recommended credit cards at http://www.debtsmart.com/cards/. This list of cards is the first line of defense you have against any one bank that's strong-arming you with high rates.

That said, even if your rates are all at 0%, you'll need to pay back the debt with cash at some point. However, it doesn't make any sense to continue paying back high-rate debt with all your power (all your cash) until you get your rates down--down by transferring balances; down by negotiating with creditors. That's why I wrote, Talk Your Way Out of Credit Card Debt. Because rate reduction is the smartest first move in controlling the cost of debt.

I always get feedback whenever I talk about buying a car using a credit card. That's because it seems like it would be more costly to use a credit card to finance a car. I can say from experience, however, that the savings can be huge. Of course, this may not be a strategy for everyone, but it is an option, and it's "debt smart" to consider all your options. Don't dismiss the possibility of saving money without consideration.

You are correct that when financing a car with a 5-year loan, the term cannot be changed without refinancing. And I would say that if someone does need to refinance that loan, it would be more costly because they may not get a better interest rate, and they may have application fees or other costs in getting it refinanced. That's why a credit line is a good option for those who believe they may need to refinance or extend the term of the loan.

I love how you use the math in your example. Thank you! Math is the tool we need to figure out which deal is best. It's our weapon against banks that try to confuse people with the numbers. Math doesn't lie. Math doesn't change. Five hundred years from now, physicists may find new particles in the universe, but 2+2 will always be equal to 4.

Let me review your example:
If you took out a 5-year car loan for $15,000 at 6%, your total interest is $2,400. If you purchase the same car $15,000 at a special credit interest rate of 3%, but take twice as long to pay it off, it will cost you $2,402. It would be easy for someone to say, "Well, just pay it off early," but you and I know, that is easier said than done. And this is the point I want you to address in your future advice. Paying off debt is a psychological issue. The psychology of paying off your debt fast and using your credit to make money not spend it.

First, the $15,000 at 6% needs $290.00 per month to repay in 5 years ($2,400 in interest). The 3% loan requires $269.54 to retire in 5 years. For that to take twice as long, the 3% loans needs a monthly payment of $144.85 to pay back in 10 years.

Doing a little more math shows that $144.85 x 120 months (10 years) = $17,382 or $2,382 in interest (not $2,402). So it turns out that you can take twice as long and still pay less! Even if you paid back the same amount in twice the time, YOU WIN! You win because your monthly payment is lower, and inflation will make your payment easier to get in the future. Wages will be greater, prices will increase, etc. and these factors make putting off the payment a smart move under certain conditions.

More obviously, Money Market Account rates are around 5%. If your loan is at 3%, then you make 2% by not paying it off. If you would have been paying $290 per month at 6%, but instead pay $144.85 at 3%, you can invest the difference ($145.15) at 5% with no risk and pocket the after-tax cash.

Moving on to the point of it being easier to say "pay it off early" when there is no pressure, I do agree that it may be easier said than done--but not in your example. When we compare the two loans: $290.00 per month (6%) and $269.54 (3%), I believe it would be "easier" to pay $269.54 per month than $290.00. The only difference is that the 6% loan forces you to make that payment or face penalties, which I consider to be a BIG con! The credit line financing would have a much lower minimum payment so you would need to be disciplined and pay the $269.54. And you're right in that there is going to be a temptation to spend the money instead of making the payment.

Yes, there are psychological factors; however, I'm not a psychologist. You, like the majority of DebtSmart readers are "DebtSmart." That's what I've found. You understand that to get the benefit of a low rate, you must make the same payments as you would with a higher rate. My focus at DebtSmart is to bring information, sometimes out-of-the-box or unconventional, to your attention. I want to spark the imagination of my readers so they see more credit options that will save money.

Best,
Scott

Reader Comments
" I enjoy Scott Bilker's advice a great deal. This article, Paying off debt is hard work, like others he has written shows a flexibility and insight that I do not see in 97% financial advice columnists. I like his comment about the reader's ho-hum cliché opinion about paying off debt as 'a brute force approach.' Almost everyone views credit cards and debt in that same black and white fashion--seriously overlooking the ways credit can make our lives better, other ways in handling debt and the whole other real world situations that canned financial advice can't even begin to remedy. Scott is really the only debt advisor I read on a regular basis anymore. I am also a librarian in a large urban library who is in charge of the finance collection. I have all of Scott's books for the public to read."
--Michael Skidmore, Librarian

--End--

 

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