In my last post I mentioned, the idea of getting on a bi-weekly payment plan. To be honest, I have always paid rent in bi-weekly installments so that we didn't have to take a huge hit on one paycheck and then have to make the second check of the month last the rest of the time. So, for our $750/month rent, I pay $375 from the first check and $375 from the second check. Now, as long as I am renting, this doesn't make any different at all in my debt. However, on the average 30 year mortgage, it is possible to cut 5 years off of your loan by paying bi-weekly instead of monthly, AND you can save tons of money in interest!!!
Consider this: if you are paid every other week, you will receive 2 paychecks per month on average. However, there are always exactly 2 months out of the year where you will receive a third paycheck. So, when I pay my rent bi-weekly, the effect is that at the end of the year I have paid an extra full month of rent because I still set aside that $375 every paycheck, whether I got 2 checks or 3 in that particular month. When it comes to debt, that means that you made a full month extra payment just by splitting your regular payment in two and paying that amount every time you get paid. Now, you would think that this would not make such a big difference because it is only one extra payment in a year, so it would theoretically take you 12 years to make 12 full extra payments, and cut off a year, but this is a logical fallacy of sorts. In fact, making bi-weekly payments actually has an even bigger impact on your loan because it disrupts the interest accrual on your loan every 14 days.
What I mean by disrupting the interest cycle is that over the course of a single month you may accrue X amount of interest normally on your loan. By splitting your payment, you are only accruing 1/2X for the first half of the month, and then your payment is paying off that interest and partially being applied to your principal as well. So for the second half of the month, your interest is even smaller because it is based on a smaller principal loan amount. That means that every 14 days you are paying off the interest and putting a dent in the principal that lowers your interest for the next 14 day period. At first this may seem like you are making a tiny difference, perhaps only a few cents at a time. On the other hand, on a 30 year mortgage of a $200,000 house, it can add up to nearly $34000 in savings over the course of the entire loan.
Now, there is no reason this won't work on student loans like it works on mortgages. In fact, I found that I was able to search for "biweekly payment calculator" on yahoo, and came up with a few different choices. I re-purposed them by putting in our student loan information instead of mortgage information, and was able to see how much I would save by using this method even on the smaller scale. For instance, the AES loan (which now sits at $27,929 and 6.71%) is estimated to be paid off in 2029 on the current repayment plan. With the snowball method I was able to save 7 years on that and move it up to 2022. And with the bi-weekly payment plan I can potentially cut another 2 1/2 years off!!!! That is 9 1/2 years off of a loan that was on a 25 year repayment plan originally! The bi-weekly payment plan will save us $2400 in interest by itself, without counting the interest saved by the snowball method.
This doesn't just apply to big loans either. It can be used for anything at all. Naturally, the bigger your starting balance is, the bigger a difference it will make, but any time and money you can save is completely worth it to me!
Anyways, the point of this post is that even if you are not able to set aside a lot of extra money to make bonus payments with the snowball method, you may be able to make a substantial difference just by splitting your payment between two checks instead of paying it all at once. (I have also found that if you split your payment, you are more likely to make a small bonus payment of $5 or $10 each time because you won't be taking such a huge hit to any single check.)
Saturday, November 24, 2012
The New Plan: 2013
As we draw closer to the end of the year, I think it is time to evaluate ourselves on our progress and think about how we can do even better moving forward. There were certainly some things that went well this year, but there were other areas where we failed almost completely. Here are the areas where I think we could improve the most:
1) Consistency of Savings
2) No New Credit Card Debt
3) Improved Payment Plan
First of all, Jason and I have already come a long way in the teamwork department. To begin with, this debt payoff plan was a product of my own wishful thinking, whereas Jason was mostly indifferent to my intentions. In fact, I believe he resented my pet project for a while because he felt unfairly targeted for mistakes he made in his past. Alas, my intention was not to paint him as the bad guy, but to demonstrate how some common misconceptions of debt can lead to much larger problems long-term, and specifically to explain some of the numbers we are dealing with here.
This year, I decided that Jason needs to be a bigger part of the conversation. We sat down together with all of the numbers and looked at everything together. We discussed major purchases in terms of wants and needs, and we made decisions about what our primary goal is. So here we are, looking forward to 2013, and hoping to stick to this newly renovated plan.
1) In the savings department, I would say we failed miserably for the year of 2012. I believe we started this mission near the end of May or beginning of April, and set a goal of roughly $300/month for savings. It is now the end of November and we have only $5 in savings. In all fairness, our car broke down and cost ~$2500 to repair, which drained everything we did have saved AND took all of the money that normally would have gone to an extra loan payment. This series of events was pretty demoralizing after so many months of great progress, which led to us not picking up where we left off. (Go ahead, take away all my gold stars. :( ) It has also presented us with another problem as we wind up the year. We need to have the money for closing costs on the house ready at the beginning of the year, and there is just no way that we are going to be able to save up enough in time, so we are pretty much left with just our tax returns to hopefully carry that weight. BUT, it's never too late to get started, so we are already making progress on this goal again, and even if we don't have as much as I had originally planned, we will have some.
2) Credit card debt became a problem for us around the same time the car broke down. Since all of our cash was going into the car, we were dependent on the credit card for everyday expenses for a while, and even raised the limit to $400 to get by. I also ended up buying a new computer on a separate card (which is actually in my own name and serving to raise my credit score before we attempt to qualify for the mortgage). On the plus side I did pay off the entire balance on the $400 card today, which was nearly maxed, and it is going into the safe to be locked away for a few months. My new card is also locked away and is being paid off $100 at a time, and should be completely paid off by the middle of January. We plan on using these cards once a month for small purchases to keep the accounts open and building credit history, but also paying them off every month so that they are not carrying any large balance. We accidentally made the mistake of not using the jewelry store credit card for too long, and they closed our account for us which was effectively a negative mark on Jason's credit report for having an account that was open for too short of a time. Woops.
3) Further research has given me additional insight into the loan paydown process. I plan to share this new method of speeding up your payoffs in my next post, so I won't ramble about it here, but I will say that this new method works with or without a bonus payment, and may be a viable solution for people who just can't squeeze any more out of their regular monthly budget to pay extra on a loan. It really is simple, and it comes down to making bi-weekly payments instead of monthly payments, but I will go into further detail later.
So these are the three areas that we think we can do better in, and make the biggest difference. I also plan on being more consistent with my blog again now that things are back in order around here. On another note, since the car broke down and we spent a small fortune on fixing it, and then we quit making our bonus payments on the loans, we actually did use that money to get all of our Christmas shopping out of the way, so from here on out, our budget is actually back to normal, and we don't have to set anything else aside for holidays!
Alas, our primary goal remains to pay off all of our debt, and to qualify for the mortgage near the beginning of the year, and now we are ready to give it another shot!
Happy Holidays!!!
1) Consistency of Savings
2) No New Credit Card Debt
3) Improved Payment Plan
First of all, Jason and I have already come a long way in the teamwork department. To begin with, this debt payoff plan was a product of my own wishful thinking, whereas Jason was mostly indifferent to my intentions. In fact, I believe he resented my pet project for a while because he felt unfairly targeted for mistakes he made in his past. Alas, my intention was not to paint him as the bad guy, but to demonstrate how some common misconceptions of debt can lead to much larger problems long-term, and specifically to explain some of the numbers we are dealing with here.
This year, I decided that Jason needs to be a bigger part of the conversation. We sat down together with all of the numbers and looked at everything together. We discussed major purchases in terms of wants and needs, and we made decisions about what our primary goal is. So here we are, looking forward to 2013, and hoping to stick to this newly renovated plan.
1) In the savings department, I would say we failed miserably for the year of 2012. I believe we started this mission near the end of May or beginning of April, and set a goal of roughly $300/month for savings. It is now the end of November and we have only $5 in savings. In all fairness, our car broke down and cost ~$2500 to repair, which drained everything we did have saved AND took all of the money that normally would have gone to an extra loan payment. This series of events was pretty demoralizing after so many months of great progress, which led to us not picking up where we left off. (Go ahead, take away all my gold stars. :( ) It has also presented us with another problem as we wind up the year. We need to have the money for closing costs on the house ready at the beginning of the year, and there is just no way that we are going to be able to save up enough in time, so we are pretty much left with just our tax returns to hopefully carry that weight. BUT, it's never too late to get started, so we are already making progress on this goal again, and even if we don't have as much as I had originally planned, we will have some.
2) Credit card debt became a problem for us around the same time the car broke down. Since all of our cash was going into the car, we were dependent on the credit card for everyday expenses for a while, and even raised the limit to $400 to get by. I also ended up buying a new computer on a separate card (which is actually in my own name and serving to raise my credit score before we attempt to qualify for the mortgage). On the plus side I did pay off the entire balance on the $400 card today, which was nearly maxed, and it is going into the safe to be locked away for a few months. My new card is also locked away and is being paid off $100 at a time, and should be completely paid off by the middle of January. We plan on using these cards once a month for small purchases to keep the accounts open and building credit history, but also paying them off every month so that they are not carrying any large balance. We accidentally made the mistake of not using the jewelry store credit card for too long, and they closed our account for us which was effectively a negative mark on Jason's credit report for having an account that was open for too short of a time. Woops.
3) Further research has given me additional insight into the loan paydown process. I plan to share this new method of speeding up your payoffs in my next post, so I won't ramble about it here, but I will say that this new method works with or without a bonus payment, and may be a viable solution for people who just can't squeeze any more out of their regular monthly budget to pay extra on a loan. It really is simple, and it comes down to making bi-weekly payments instead of monthly payments, but I will go into further detail later.
So these are the three areas that we think we can do better in, and make the biggest difference. I also plan on being more consistent with my blog again now that things are back in order around here. On another note, since the car broke down and we spent a small fortune on fixing it, and then we quit making our bonus payments on the loans, we actually did use that money to get all of our Christmas shopping out of the way, so from here on out, our budget is actually back to normal, and we don't have to set anything else aside for holidays!
Alas, our primary goal remains to pay off all of our debt, and to qualify for the mortgage near the beginning of the year, and now we are ready to give it another shot!
Happy Holidays!!!
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