When we started on this blog journey in earnest 4 years ago, we were heavy in debt, couldn’t afford our house, short on income, and short on assets. We’re heavy on debt today, can afford our house, income has improved, and assets are increasing. Something remains off. Too much of our money goes toward interest every year. Today, I’ll share a simple way how to minimize your lifetime interest. Make your money work harder for you.
Step 1 – What do you owe interest on?
Make a list of where you owe interest. For us, it is our mortgage, second mortgage, student loans, and Tesla (yes, we’re paying monthly for our damaged car).
Step 2 – Calculate your lifetime interest for each loan
It’s easy to calculate lifetime interest. Take your monthly payment, multiply it by your loan amount, subtract your starting loan balance.
(MP x #P) – LB
Fake example: our monthly mortgage payment was $2,040. We took a 30 yr mortgage at 5%. so 360 payments. The loan value was $380,000.
Plugging in:
(2,040 x 360) – 380,000 =
734,400 – 380,000 =
$354,372 in lifetime interest. That’s a lot, almost 90% of our original loan.
Create a simple table of your lifetime interest.
Mortgage $354,372
Student Loans $40,000
Car $20,000
Credit cards $13,183
Total: $427,555
Step 3 – Simulate making a large payment to all of your accounts
You can use this handy Bankrate tool to see your lifetime Total Interest Paid.
Suppose you had $10,000 in credit card debt. You hope to pay it off in 10 years, and you have a 19.99% interest rate. The current total interest paid is $13,183. You want to make a $2,000 lump sum payment. How much does your total interest paid decrease? The new total interest paid is $10,546. That’s a decrease of $2,637.
Repeat the same exercise for each loan. Which ever is the largest decrease is what you should pay down first. Let’s try the mortgage above with a $2000 payment.
Our new loan is $378,000, at 5%, for 360 months. What’s our new lifetime total interest paid? The answer is $352,507, a decrease of $1,865. Between the credit card and the mortgage, it makes sense to payoff the credit card first. Intuitively, it makes sense to payoff a high interest, low balance account before a low interest, high balance, tax beneficial mortgage. Our interest is about 130% of our principal for the credit card. The mortgage will allow you to deduct interest on your taxes. The credit card has zero tax benefit.
Many sites will suggest you get a balance transfer offer at 0% to help pay off your credit cards. That’s sound advice. Be careful of two things, getting a balance transfer and running up new credit card debt, and the major hit from opening a new account and maxing it out on your credit score. Build up your credit score first before taking a balance transfer offer. Don’t take on more credit card debt while paying off your old debt.
Remember, payments made on debt that is new will have more impact on interest than debt that is old (except variable debt).
Sincerely yours,
smilingdad
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