Why do you have debt? Why does most of your income go towards debt?
Typically we desire to have things, an education, a car, a home or other things we don’t have adequate savings for pay for these larger ticket items outright. We then go into debt with a lender to obtain the funding to purchase things now, rather than wait.
When you accumulate loans on top of living expenses, you may find your income shrinking rapidly making extracurriculars such as travel and hobbies harder to do.
Why you don’t like loans?
Why you want to pay your loans off as soon as possible?
Usually the main reason is the Interest.
So, what is interest?
Interest is the price of the loan, it is the cost that you have to pay to the lender for the money that you receive now as you pay them back later. It compensates the lender for the decrease in the value of the money when he receives it in the future due to the inflation rate “increase in the price level”
Once you know about interest rate, knowing the total cost of your debt will help you analyze where your money is going and make a strategy to lessen the extra money leaving your pocket unnecessarily.
How do we calculate the cost of debt?
Cost of Debt = Interest Cost
Interest Cost = Amount of Loan x APR x Time
APR = Interest Rate + Any Other Costs Charged by Lender
The Rena-Fi debt reduction strategy is simply based on “Cost Reduction Methodology,” or paying high cost debts first.
What are the high cost debts or the “Big Sharks”?
High cost debts are debts that carry a high interest rate or cost to you.
You should pay those loans first because this will allow you to reduce your cost dramatically and save more money to pay the lower cost debts with lower interest rate.
Now that you have the basics, here’s how to put it into action with your unique financial situation.
- Prepare Your Monthly Budget
List your monthly income from different sources and deduct from it all your monthly expenses, loan payments. Extra: Don’t forget to set a side at least a 3-6 months emergency fund
2. Find Ways to Create a Surplus (Income > Expenses)
By looking for extra sources of income or by cutting some unnecessary expenses, you can create a surplus. Extra: Set a target of at least 20% of your income as a surplus to achieve.
3. Use the Surplus to Pay Down Your Loans
Take your surplus and apply it towards the principal of your loans by starting with one loan at a time. Don’t forget to start with the big sharks first (highest APR).
OR If you want to get immediate positive cash flow improvement, pay the loans with the highest payment to loan ratio.
OR If you want to pay the least in the long run, pay the highest interest loans first.
QUESTION: If you had a zero-interest loan, why would you worry about paying it back quickly?
Try some other ways to apply our cost reduction strategy and principals:
Assume you have the following debts:
- Personal Loan with outstanding balance $10,000 and 15% APR.
- Student Loan with outstanding balance $7,500 and 6% APR.
- Car Loan with outstanding balance $5,000 and 4% APR.
If you were to get a $1000 bonus from your work, how could you use it to reduce your loans burden?
- Paying $1000 toward the outstanding amount of your personal loan will save you annually:
$1000 x 15% = $150
2. Paying $1000 toward the outstanding amount of your student loan will save you annually:
$1000 x 6%= $60
3. Paying $1000 toward the outstanding amount of you personal loan will save annually:
$1000 x 4%= $40