One of the hardest parts about paying off your debts ahead of schedule is, until the balances are actually gone, you will not realize any benefits. In fact, in the meantime, it will actually probably be quite painful and annoying.
This is exactly why paying off debt on any kind of accelerated schedule is such a huge pain in the ass. How often do you do things that suck, make you feel broke, and stop you from going on vacation for two or three or more years? Probably never. Nobody willingly does that.
I’ve recently stumbled upon articles and blog posts by people willingly ignoring their debts. They opt for the minimum payment, because then it gives them more money to put into other investments, like retirement accounts or an emergency fund. If you don’t do any number crunching, this can almost sound like a good strategy — after all, you’re not neglecting your debt to spend more at the mall, you’re being responsible! But if you understand that a dollar is a dollar is a dollar, you know dragging out your student loans over 10, 15 or 25 year terms just for the sake of having more cash in-the-now is an excellent way to shoot yourself in the financial foot.
Example: imagine a $10,000 loan at 5% with a 10-year repayment term. Your monthly payment would be $106 per month, and over the lifetime of the loan, you’ll pay just over $2,700 in interest.
This is a small enough loan that many people would not feel in a hurry to pay it off. The interest rate is low enough not to lend any sense of urgency. The minimum payment is small enough not to dramatically disrupt anyone’s budget, possibly small enough not to be a bother at all. This is exactly why it’s such a battle to get anyone to make pre-payments on their loans: there is virtually no immediate incentive to do so. I get it.
But there are major long-term incentives.
It takes so little to get ahead
The first thing I want to address is it literally takes small peanuts to make a big dent in your debt.
Media sings the praises of people who wipe out massive sums in 2 or 3 years or less, and rarely praise the debtor who vanquished their debt in 7 years instead of 10. But that doesn’t mean they didn’t win a real battle.
Remember, you don’t actually have to whittle the balance down to zero in record time in order to realize the benefits of paying your debt down fast.
In fact, tossing as little as an extra $50 to $100 per month at your loan will likely result in a huge payoff.
Every time you make an early payment towards your debt, you’re buying time at the end
Repaying debt can feel like an exercise in futility. Making a big payment this month will not reduce your payment next month. Making 12 payments in the first six months of the year will not let you make fewer payments for the remainder. In this context it might feel like there’s no incentive to get to debt-free early.
But there is.
Every time you make an early payment against your debt, you knock time off at the end of the loan.
Often you don’t even need to make full extra payment in order to knock a full month off the term. Because of the interest that will accrue over the lifetime of your debt, reducing the principle early on reduces the amount of money that will accrue for the rest of the repayment term.
In our $10,000 loan example, one extra payment of $75 at the beginning of the repayment term will knock 1 month off the loan term at the end. This means you’re essentially getting $106 worth (one payment) for $75. That’s a $31 difference or a 41% return on your investment.
Make this extra $75 payment for 9 months in a row, and you knock off 10 months off your loan.
If you’re getting frustrated with your debt, stop looking at the balance. Start looking at the number of months you will no longer have to be in debt for. It’ll cheer you up.
The more months of early payments you make, the faster your debt-freedom date draws nearer. And the less interest you pay.
The money you save on interest by paying your debt early is real money.
The numbers in your spreadsheet can feel intangible. They are so easily altered by a minor change in variables. They seem unreliable no matter how many times you check the math. It’s like they’re not even real.
But the money you save by making early debt payments is real money. You can spend it on other aspects of your life.
Using our above example, let’s say you decide to stick to an extra $75 per month payment on top of the minimum $106 payment until your debt is paid off. You’re going to get out of debt in 63 months, which is nearly 5 years early. But you’ll also save $1,300 in interest.
This $1,300 is real money. To really understand this, you should revisit my post This Exactly How Much You Will Earn & Spend In Your Lifetime.
Picture the loan as part of a lifetime spending account. In one scenario, you stick to the minimum payment schedule and it costs you $12,727. In the other, you make your extra $75/month payments and the loan costs you only $11,410. You can allocate the difference to any other area of your life. You can spend it on travel, clothing or food. You can save and invest it. You can do anything you want.
Ideally, you’ll invest the money. But honestly, virtually any use of it is better than relinquishing it to a creditor. I want you to put that $1,300 into a retirement savings account. But if you spend it on a vacation, I won’t begrudge you. After all, you’ll probably really enjoy the vacation, whereas I doubt you enjoy paying interest.
If you graduate from university at 22, this is the difference between being debt free at age 27 instead of 32. And $1,300 richer.
Don’t tell me you can’t afford that.