Q. I have a debt of $50,000 from balance transfers and credit line accounts. If I were to pay just the minimum due every month (which is what I can afford now) how long will it take to clear, including 24 percent interest per year? I really want to clear it fast.
A. Balance transfers, teaser interest rates and interest-only payments on lines of credit only serve to put off the day of reckoning. I hope you’ve been putting some money aside while waiting to pay down your debt, because it sounds like you’re ready to take it on, and the extra savings will soften the blow to your monthly cash flow.
As long as you are paying the minimum amount due on your revolving credit card accounts, you won’t get anywhere fast. Here’s why: As you pay down the principal amount each month, the minimum payment will go down, too, as the minimum amount due is figured as a percentage of the principal — the lower the principal, the lower the payment. The result is that you make less progress each month.
Here’s an illustration: You made a minimum payment of $1,500 this month. The principal amount reduces by $500 to $49,500, and your next month’s minimum payment decreases to $1,485. So, after making a year’s worth of minimum payments only, although your principal amount would be down to $44,319.01, your minimum payment will drop to $1,342.99. By year five, your minimum due would be down to $829.01; by year 10, the minimum due would be $453.66.
If you were to continue to make only the minimum payment, based on the industry formula of the interest due plus 1 percent of the balance, can you guess how long it would take to completely get out of debt? It would take more than 42 years to pay off your current $50,000 balance, and your total cost would be a whopping $99,336.04. Nasty indeed!
A better idea, and one I think you have already figured out and can afford, is to continue to make the minimum payment you are making now of approximately $1,500 per month every month regardless of any drop in the minimum required until the balance is paid. If you were to do so, you could pay off your debt in less than five years with a total payoff of $83,220.87, a savings of $16,115.17. Sweet indeed!
Here’s your payment formula: (Interest due) + (1 percent of the balance) = minimum payment.
But paying down your debt shouldn’t be your only goal. I want you to avoid accumulating this kind of large debt load in the future. How? It’s easy. Save some money you don’t have. Here’s how that works: Every raise, promotion, tax refund or windfall must be split 50/50 between you and your savings account. This is money you don’t yet have, so you won’t miss it. I want you to build an emergency savings account while you are paying down your debt with a goal of stashing at least six months’ worth of living expenses.
I know that sounds like a lot, but once you get going, it will take on a life of its own. Pay yourself first. That may mean you skipping a few meals out or make other small sacrifices during the month to get going. But the sooner you do, the better you’ll feel.
Steve Bucci, is the former president of Consumer Credit Counseling Service of Southern New England and the author of “Credit Repair Kit for Dummies.”