Managing Debt

Paying Principal & Interest

When paying back loans, it is important to understand that your whole payment each month is not going toward the principal (the amount you borrowed). Some of it goes toward the interest that you owe. The higher your remaining principal balance, the more interest will owe.

There is some good news: As you pay down your principal, less interest will be charged. If you pay extra each month, that money will go toward your principal balance. This is why paying extra (when you can) is a great money-saver. By lowering your principal balance, the interest charged will be less than it would have been had you made only minimum payments.

Paying Off Debt vs. Earning Interest on Savings

So, you have somehow accumulated some extra money. Now you need to decide whether this is money that you save or money that you use to pay down some of your debt.

Again, the most important thing to consider is interest rate. Let's assume that you have a loan with an interest rate of 8.99% and you are are earning 1.50% on the money in your savings account.

According to the information above, you're paying more interest than you're earning. It’s clearly better to pay down your loan with that extra money instead of adding all of it to your savings. (Paying down your loan is usually going to be your best option, just make sure you’re still saving some money.

Deciding Which Debts to Pay Down First

It is important to make at least the minimum payment (and make it on time) for each bill or loan that you have. With money left-over, work toward paying your full balances and maybe even paying some extra.

There are many things to consider when prioritizing which debts you will apply more money to:

What is the interest rate?
How long is the loan term?
What is your monthly payment?
Is the loan giving you any benefit?

You will want to start paying whatever has the highest interest rate first – this will probably be a credit card, personal loan or even a car loan.

You will find that educational loans generally have lower fixed rates and they offer a tax break. If you have to keep a loan full-term, this may be your best choice.

Trouble Making Payments

You may run into a situation where you are unable to make payments on a loan or on other bills such as utilities.

If this happens to you, the most important thing to do is to notify your creditor. Most creditors are willing to set up a payment plan or work something else out as long as you notify them of your problem and continue to make some form of payment. It’s better to pay something than nothing at all.

The Magic of Minimum Payments

Making the minimum payment on a loan is just fine... unless that loan has a high interest rate. Prime example: Credit Cards. Let's go over how a minimum credit card payment works:

You spend $500 today and in about 30 days you'll be billed for a minimum payment of $20. You like the idea of paying $20 instead of $500, so you make the minimum payment. You decide to keep on making the minimum payment. Months later (and by 'months', we really mean 'years'), you'll finally pay off that $500... plus you'll pay over $100 interest. Ta-da! Like magic, you've turned your $500 purchase into a $600 payment. How do you like that trick?

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Words of Caution

Credit Counseling/Repair Services

If you are having trouble with your debts, try to stay away from credit counseling services. Instead, work out a payment plan directly with your creditor.

Remember, credit counseling services are businesses – in it to make money. Using these services could end up costing you more money, and they don’t always pay off your bills like they say they will.

Most importantly, it will show on your credit report that you are in credit counseling. The only time to consider credit counseling is as a last resort to avoid filing for personal bankruptcy.