Early Payoff: Do the Math and Get Excited

by Jessica Sommerfield · 0 comments

Most people have debt. Even if you don’t have ‘bad debt’, such as credit card balances, you’ve probably had to take out a loan at some point for major purchases such as a vehicle or home. If you’re interested in becoming more financially secure, however, debt reduction is major step.  The most effective way to repay your debts is often referred to as a snowball effect — paying off the smallest debt you owe, which frees up funds to roll on to the next largest debt, and so on. Other financial advisers suggest paying off the debt with the highest interest rate first, or consolidating all your debt into one low interest rate credit card or loan.

Getting motivated
Whatever your preferred method, debt repayment can be hard because it requires sacrifice, and often takes a long time. This gets discouraging.  One way I’ve discovered to put some motivation and excitement into debt elimination is to calculate the unearned interest if you pay off your debts early.  When you look at what you owe, it’s easy to overlook the factor of finance charges. The amount you originally finance with your bank or lender isn’t what you pay. The lender charges you interest, usually accrued on a monthly basis, which increases the total amount you end up paying back.  Because of this, the earlier you pay off a debt, the less you’ll be paying in interest. 

But how do you determine how much interest you *won’t* be paying on your debt if you pay it off, say, today??  
That’s a good question. In the financial world, there are a few formulas used to do this, known as the actuarial method, and the Rule of 78. If you’re like me, you don’t want to know or do any more math than you have to. Thankfully, there are so many online financial calculators these days, you won’t have to do anything but plug in the specifics of your loan to find out what you’ll save. Sites such as powerofinterest.com or freecreditscore.com offer such calculators to help you figure out what you won’t owe if you pay now.

Of course, you might not have enough free funds to completely pay off your debt right now. Even eliminating several payments from your remaining number of payments makes a big impact on how much total interest you’ll be paying. The key is to make extra payments whenever possible so you will pay off your debts early. An easy way to do this is to use large, unexpected or un-budgeted sums of money, such as income tax returns, side jobs, or money gifts (instead of spending them).

If you do this, you will:

  1. Be debt free sooner, which means more financial freedom for savings goals
  2. Pay less financing charges, which also saves you money
  3. Improve your credit score, which will give you better loan terms in the future (and, you guessed it — saves you money)

Debt elimination is never easy. It’s a discipline and a process, but the reward is always worth it. Use this method to get you motivated, or find your own, but find some inspiration and achieve your goals.

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