Living free of unsecured debt, even free of all debt, may seem impossible. Small wonder, every day we’re bombarded with the idea that using credit cards is the way to a good life and the notion that incurring the debt of driving a new car or paying a mortgage is just the way things are done.
What the advertisements never tell us, at least in a way that’s clearly understood, is the actual cost of that debt. In fact, they don’t quite make it clear is how that debt actually works.
Debt falls into two broad categories, secured and unsecured. Secured debt means that if you can’t pay the debt, you have to give back the item. This type of debt is reserved for items like cars, fine jewelry, fine art, and houses that have true resale value. The amount of the loan is usually figured not only on your credit but on the value of whatever is being financed. Of course, if the economy falters, you may well find yourself upside down as so many people with home mortgages are discovering today.
Unsecured debt, which most of us know as credit card debt, has no security. If you charge a pair of $100 boots and can’t pay for them, the credit card company can’t take back the boots, but they can come after you in many other ways.
Although you never see the cash, with both secured and unsecured debt you’re actually borrowing (making use of) money from a third party to pay for the purchase. You then owe that third party both the amount borrowed plus the interest or rent on that amount. Interest is expressed as a percentage that you’ll pay on the balance or principle that you owe. How much interest you’ll pay depends on a number of things, but as a general rule, interest rates on secured debt are less than on unsecured debt.
Although the law insists that lenders let you know how much you’re paying in interest, expressed as APR which stands for the Annual Percentage Rate of your loan, it’s not always clear exactly how much a loan actually costs you. It’s startling.
Take, for example, a $300,000 mortgage payable over 30 years at 6% interest. According to BankRate.com your total payments will be $664,975.79 of which $364,975.79 is interest. You’re paying more in interest than you are for the property. (Search on total interest paid to find calculators that will give you this information.)
Credit cards are even more frightening. Assume you have $10,000 in credit card debt with an interest rate of 18% and you’re making the minimum payments which start at $250 a month. If you never charge another thing, it will take 382 months, or almost 32 years to pay that debt. Even though your minimum payments will go down a bit each month, you’ll pay a total of $14,615.49 which is in addition to the $10,000 which you also must pay back. If you’re credit is good enough to get you an 11% interest rate, you’ll end up paying a total of $5,658.75 and it will take you 252 months or 21 years to pay off. (Search on how long to pay off credit card debt to find the calculator you need.)
You owe it to yourself to figure out exactly what you owe and what that debt is costing you. That’s the only way you’ll be able to make a sensible choice about it.
You can move to being debt free it in three steps:
1.
Know what you’re spending track every single penny you spend for at least a month. This gets you out of vagueness and lets you start making good decisions about your money.
2.
Start Saving set up an automatic savings plan. Ideally you’ll save 10% or more of everything that comes in, but if you can’t do that in the beginning, you can automatically save $10 or $20 every time you get paid. Once you’ve got $1,000 or so in your emergency fund you’ll start feeling better about your money.
3.
Begin paying off your debt find out exactly how much you owe, and pay the minimums on everything but one debt. Pick one, maybe your smallest so you can see progress, and up the minimum payments. Make sure the extra money goes to the principle (you may have to call the company to find out exactly how to do this) and continue until that debt is paid off. Congratulate yourself and move to the next one. Continue until your debt free no matter how long it takes. And it will probably take less time than you expect.
Obviously, you’ll probably have to make at least minor reductions in your expenses, and more probably major cutbacks. Or you may have to find a way to increase your income, or maybe even both.
Move into your plan to get debt free gently, but do it. Don’t deprive yourself too much; if you do, you probably won’t follow through. A huge motivator can be looking at the amount of money your debt is actually costing you. Then ask yourself what would your life be like if you didn’t have that debt? What would your life be if you paid off your debt and lived debt free?
You can begin to get and stay debt free right now. Go for it.