You should always be open to paying down your debt (even if the interest rate is low) with new debt carrying a lower interest rate. The benefits in each individual case may seem small, but over the course of a lifetime the cumulative effect of hundreds of wise decisions could significantly impact your ability to retire.
Be Your Own Business Manager
Many people are exceedingly responsible with their employer’s money. In our experience, they’re also exceedingly illogical in utilizing their own money. At work, people will agonize over minor expenses, try to conserve business resources like printer ink, and try to find ways to save the company another .1%. Unfortunately, most people fail to carry over those behaviors into their personal lives. If you’re reading this site though, you’re definitely not ‘most people’.
The people around you will often avoid thinking about their debt, burying their head in the sand to avoid unpleasant thoughts. They’ll ignore the long-term consequences of some of their actions. Maybe they’re stressed out, embarrassed, or angry about their prior decisions. Or, maybe, they think interest calculations are too complicated and not worth the hassle.
Whatever their reasons, don’t follow in their footsteps. Instead, every time you review your finances, approach them with a fresh set of eyes like you’re a new manager of Company You. You should evaluate your debt and explore alternatives. Companies restructure their debt all the time, and you should too (if it makes sense). If you are offered an opportunity to trade higher interest debt for lower interest debt, and associated fees (like loan origination costs) are not significant, you need to have some strong reasons supporting any decision to maintain the status quo. The same benefits exist for you as an individual that exist for companies, even though you’re dealing in hundreds or thousands of dollars instead of millions.
Where Can I Find Cheaper Debt?
There are a few easy ways to find lower cost debt:
- Credit cards may offer a 0% introductory rate as part of a sign-up offer
- Credit cards may offer you a 12- or 18-month 0% rate if you’ve been a loyal customer.
- Local credit unions may have better rates for homes and cars than larger banking institutions or dealerships
- Interest rates may have changed since the time you took out the debt, so you may wish to refinance through your original lender or a competitor
As of yesterday morning, I still owed ~$5,400 on my 2013 Nissan that I bought new when I was a little less financially responsible. Every month I slightly overpay my car payment with a $450 payment, so I have a little over 12 months to go (in February) to pay this beast off. The interest rate on this debt is extremely low – 1% annually. One additional wrinkle is that I pay with a credit card, incurring a $12.95 credit card usage charge every month. I do this strategically, to hit credit card sign-up or spend bonuses, and collect points that even out this charge.
Yesterday I received an offer on one of my credit cards for a twelve-month 0% interest rate on new purchases. This offer matched up so well with the timing on my outstanding car loan, I started thinking about whether I should enroll in this offer and pay off my car. I created the following table in Excel to see how much I would pay if I kept paying $450/month on my car loan and discovered I would pay $5,584.83:
|Date||Ending Loan Balance
|Mar-18||$0.00||$0 (will pay
Then I made one more table calculating how much I would pay if I used the 12-month 0% credit card offer, and started making my car payments into a holding bank account earning 1% per year. As you can see, I would only be paying the credit card processing fee once, make approximately $11.87 in interest from the bank, and pay a total of $5,412.82 towards my car:
|Date||Ending Loan Balance||Credit Card
|Car Payment into Bank
Account Earning 1%
So, if I spend two minutes enrolling in the credit card offer I will spend $171.88 less on the car itself ($5584.83 – $5424.82) and earn $11.87 in interest, for a grand total savings of $183.75 over one year. To avoid any appearance that I’m being disingenuous, obviously the gains would be lower if I were making my payments by check (~$42), but I’d also miss out on the credit card points. There are additional benefits too we’re ignoring for this post, like the fact I would be trading secured debt for unsecured debt and I would no longer be required to carry full-coverage auto-insurance.
It may not seem like that much money, but retirement is built one dollar and one paycheck at a time. If you invested that $183.75 savings for the next 30 years, assuming a 7% inflation-adjusted return, you’d have an extra $1,307.24 in today’s dollars. Based on my current living expenses, that’s two weeks less of work for twenty minutes of my time. Maybe when you do your own calculations you’ll determine standing pat is better than the hassle. That’s fine. Just going through the calculations will help you understand your debt situation better. If you understand your options, your goals will be far more attainable.