Paying a higher interest rate to get out of debt faster sounds a little odd, but just stick with me and I’ll explain.
When most people shop for a loan, what do they usually look for? The lowest interest rate, right? There is a good reason for this. All the bank advertising we see and hear almost daily has brainwashed us into thinking that interest rates are important. Advertising tells us over and over again that if we get a lower interest rate, we are better off.
Considering that banks are in business to generate as much profit as possible, it would probably be safe to assume that what they are trying to sell you is actually more in their best interest, not yours.
What you should be doing is looking at how the loan is structured.
Here is an example to help illustrate how structuring a loan differently can save you money. Here are two mortgages. Both are for a $100,000.
| Current | Proposed | |
|---|---|---|
| Interest Rate | 6.00% | 8.75% |
| Loan Amortization | 15 years | 30 years |
| Monthly Payment | $1,000 | $710 |
| a)amount towards debt | $50 | $30 |
| b)interest charges | $950 | $680 |
| Get Out Of Debt In | 15 years | 30 years |
| Total Cost Of Loan | $180,000 | $255,600 |
Right now, the proposed loan doesn’t look so great. But watch what happens when we make one small change to the higher interest rate loan.
| Current | Proposed | |
|---|---|---|
| Interest Rate | 6.00% | 8.75% |
| Loan Amortization | 15 years | 30 years |
| Monthly Payment | $1,000 | $710 |
| a)amount towards debt | $50 | $30 |
| b)interest charges | $950 | $680 |
| Added Monthly Payment | $0 | $290 |
| Total Monthly Payment | $1,000 | $1,000 |
| Get Out Of Debt In | 15 years | 30 years |
| Total Cost Of Loan | $180,000 | $255,600 |
For the same $1,000 monthly payment, the higher interest loan is paid off four years faster and saves you $48,000. The reason the higher interest loan is paid off faster is that you have more money going toward paying off the principal of the loan each month.
How a loan is structured is more important than the interest rate. By amortizing your loan over a longer period of time, you can usually get your monthly payment reduced. Take the monthly savings and use it as an additional payment on your loan each month (thus putting more toward your principal). You may be charged a higher interest rate to do this, but it will usually still get you out of debt faster and save you money.
So the next time you are shopping around for a loan, tell the lenders that you do not care about the interest rate. What really matters to you is when you will be out of debt and how much it is going to cost you. I am sure you’ll confuse more than a few of them, so have fun with it.
Tags: Get Out of Debt, Paying a Higher Interest