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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. |
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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
| " |
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 |
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