A Primer on Debt Reduction

Posted by Mike Smith :: June 25, 2007 @ 7:26 am

The road to financial freedom is a long and winding one. At times, the journey may even seem unachievable. Focusing on an intermediate goal is a useful way to start.

Remember the old saying that a journey of a thousand miles starts with a single step? For those seeking to take that critical first step and for those who are looking to accelerate their journey, reducing your debt is a worthy intermediate goal.

One of the easiest and most cost effective ways to reduce your debt is to decrease the amount that you’re paying towards interest each month. To do that, you’d like to pay off all of your credit cards, student loans, car loans, etc. as soon as possible. A good start would be by paying as much as possible toward the debt that you have the highest interest rate on.

An alternative is to consolidate all of your high interest debt into one lower, fixed rate loan. When you borrow money at a low rate to pay off debt at higher rates, you may be able to save a considerable amount of money. What’s more, you’ll also be able to pay off your debt faster since more of your money will be going towards the principal balance each month.

A simple example will help to illustrate my point:

As was reported on a recent post, “The average American household with at least one credit card has nearly $9,200 in credit card debt… and the average interest rate runs in the mid- to high teens at any given time.”

Let’s look at that example, and assume that you have a credit card balance of $9200 with 17% interest. Further assume that your credit card terms require a minimum payment of 4% of your balance, which is fast becoming the norm. With those terms, it will take you 11 years to pay off your balance and cost you nearly $14,000 with $4,753 going to interest.

Consider the alternative: If you qualify for a 3 year loan from Lending Club with a fixed rate of 10% interest, you could borrow $9200 and pay off your credit card. After paying back the loan over three years, you will have only spent $1487 in interest for a savings of $3266!

Not only will you have saved a significant amount of money, but you will also be free from your $9200 of debt 8 years sooner. Best of all, your monthly payment towards your loan would be less than the minimum payments you would be required to make when you started paying off your credit card balance. It’s a win-win-win situation!

Start organizing your monetary state of affairs and find a handle on all of the debt that you’re currently under. Consider a fixed interest rate loan, pay off that debt and kick your journey into high gear. A proper first step could make all the difference.