Authors: Gail Vaz-Oxlade
Debt-Free Forever (9 page)
Paying off expensive debt by increasing your mortgage is one of the more time-honoured ways of hiding debt. Our homes, once the anchors in our wealth-accumulation plans, have become cash cows used to finance everything from vacations to vehicles, eroding our true wealth and leaving us vulnerable to the inevitable downward fluctuation in the value of our homes. Lots of people consolidate using the equity in their homes and then pretend that everything is okay, cuz now it’s a mortgage payment. Isn’t a mortgage good debt? Hey, tell
the truth. It’s still consumer credit; it’s just been shuffled to somewhere you don’t have to look at it. And believe me, it’s costing you.
Allison and Peter have been in debt forever. They make more than $140,000 a year combined, but they can’t seem to stay out of the hole. It started with Allison’s two maternity leaves, for which they had nothing saved. They kept spending as if she were pulling in her regular income and ended up using their line of credit to fill the gap. Peter’s truck gave up the ghost, and because they’d been late with some payments, their credit score was low. That meant a higher interest rate on the new truck loan. And then there was the trip to Cancun they decided to take last winter because they just had to get away. All in all, they ended up with $67,960 in debt and the payments were killing their cash flow.
Allison had a great idea. The house they’d been living in for the past 14 years had gone way up in value. They could just fold their debt into their mortgage, which was coming up for renewal, and be done with the worry. They were paying more than 12% on average on their debt, and the mortgage would be at a much better rate: 5.15%. And if they went with a 30-year amortization, their mortgage payments would actually come down. They wouldn’t have those huge payments on the truck or the line of credit anymore, so they wouldn’t run short of money and end up having to use their credit cards to get them to the end of the month. There was no downside.
When Allison and Peter made the decision to refinance using their home equity, they made a smart choice. When they figured they’d be done with the worry, they didn’t
consider the high cost of the “peace of mind.” Repaying the refinanced amount over 30 years means the $67,960 they consolidated to their mortgage will end up costing them almost $44,000 in interest!
It makes sense to consolidate on your mortgage to save on interest, providing you put away all forms of credit, learn to live on your current income, and continue to make extra payments against your mortgage to offset the consumer debt you stuck on there. Slap as much on the mortgage as you were paying for debt and mortgage payments together and you’ll not only save money, you won’t add to the length of your mortgage.
You’ve been successful at reducing your interest rates, so now it’s time to reshuffle your Debt List so that your most expensive debt is back on top. Remember, your most expensive debt is the one with the highest interest rate.
The next step will be to figure out how much money you must put toward your debt to get it paid off once and for all. If your interest costs have gone down, so may your minimum payments. Note the changes to your minimum payments and then add up all your new minimum payments to see how much you have to pay to stay on the good side of your credit history.
While you make the minimum payments on each of your debts to keep them in good standing, paying only the minimum on your debt will keep you in Debt Hell for a very long time.
GAIL’S TIPSPerhaps the most successful ploy brought to you by lenders is the Minimum Payment Ploy. If you figure that a $2,500 trip is only going to cost you $64 a month, how can that be beat? Who can’t afford $64 for a much-needed vacation? The Minimum Payment Ploy has fuelled unprecedented growth in consumer spending, which could only have been achieved with borrowed money because it has outpaced the growth in our incomes. All that credit gives us the ability to live well beyond our means, creating the illusion that we are rich … until the payments come due.
Are you a sucker? If you make only the minimum monthly payment on your credit card balance, you are. Let’s say you’re using a credit card that charges 17.99% interest on purchases for which the minimum payment is the interest + $10 + fees, or 2.25%, whichever is less. Now, let’s say you’re carrying a balance of $3,600 and are making the minimum payment, which would be about $64 (the interest + $10). Since you’re only paying $10 a month off the amount you owe, it’s going to take a long, long time to get this card paid off. How long exactly? Well, 106 months, or 8.8 years! And do you have any idea how much interest you’ll end up paying on that $3,600 balance? $3,384. Yup, you’ll pay almost as much in interest
as you originally charged. Those shoes you bought at 40% off don’t look like such a good deal right now, do they?
Want to be debt-free? You need to figure out how much you must pay to not only meet your minimums, but to get yourself out of hock. Time for more math.
Go back to your Debt List and figure out what you’ll have to spend every month to dig yourself out of the hole. You’ve already calculated what the monthly interest cost is on each of your consumer debts. Now it’s time to look at how to get the principal paid off. Your list may look like this:
Let’s take the department store credit card as our first example. (For the purpose of this example, we’re going to assume the interest rate has remained the same because, try as you might, with your crappy credit history no one would cut you any slack.) The amount owed is $700. Your objective is to have that balance paid off in 36 months or less and avoid Debt Fatigue.
GAIL’S TIPSDebt Fatigue is what happens to you when you’ve been in a hole so long you can’t even imagine daylight anymore. You’ve lost hope. You’ve started spending again after being overwhelmed by the amount of debt you have and the seeming futility of your debt repayment process. You’ve given up and gone shopping.
Debt Fatigue is a big contributor to most people staying in debt. The sense of never being able to change things overwhelms even the best of intentions. To avoid Debt Fatigue, you have to be able to see the light at the end of the tunnel.
It doesn’t matter how long you’ve been in debt, or how big your debt is, if you want that life to be better than it has been, if you want it to be free of debt, then this is where you draw the line in the sand. You must make a plan to be consumer debt-free in 36 months or less.
How long you’re prepared to live in misery is up to you. You can bite the bullet and do what it takes to reclaim your life or you can keep mewling about how hard it is to get to even. But while you’re whimpering, you’re paying a ton of interest too, money that could be better used doing something nice for someone you love: you.
To have that credit card paid off in 36 months or less would cost you $19.44 ($700 4 ÷ 36 = $19.44). Now you have to add in the monthly interest cost, which we calculated at $16.80, for a total payment amount of $36.24. It’ll take about 36 payments of $36.24 to get that department store credit card paid off.
Take the same steps for every other debt on your list:
1. Divide the amount owed by 36.
2. Add the answer to the amount of interest you must pay each month. (Remember, to calculate the monthly interest cost, you multiply the amount you owe by the interest rate and divide it by 12.)
3. The total is the amount you must pay to be rid of that debt in 36 months or less.
Now your list looks like this:
GAIL’S TIPSSince the interest is being calculated on a declining balance, each time you make a payment, the amount of interest the following month goes down, assuming you haven’t charged anything more or that your interest rate hasn’t gone up. That’s more complicated math than most people can handle, so we’ll use a steady interest rate for our calculations. If you want a dead-on amount for your budget, you can find an online calculator that can do the math for you. For now, work through this so that you understand what’s going on.
Add up your Monthly Payments. That’s a crapload of money, isn’t it? But that’s what you’re going to have to come up with if you want to be consumer debt-free in three years or less. It may take you a minute or seven to wrap your head around your new debt repayment number.
If you were not yet convinced of how important it is to get your interest rates down as low as possible, looking at a big, fat repayment amount may be just the motivation you need to get busy reducing your interest costs. If you have tried your best and couldn’t get your lenders to move, couldn’t consolidate, or couldn’t do a balance transfer, you’ll just have to suck
it up and work with what you have. Six months of steady payments against your debt should go a long way to shining up your credit score, at which point you can call and negotiate, do a balance transfer, or get a consolidation loan to reduce your costs.
If you’ve already got your rates down as low as they will go, you’ll have to find a way to make the plan work. That may mean cutting back even further on your expenses or getting another job or two to come up with the extra money you need for debt repayment. If you’re serious about being debt-free, you’ll do whatever it takes!