Believe it or not, some times paying more principal on debt can cost you. The circumstances vary, but this was exactly the case for a couple I work with.
This is the couple I highlighted in this space a few weeks ago. The husband is a young up-and-coming attorney putting in long hours at a small law practice. The wife is a nurse who, in an ideal world, would retire already because she’s sick of dealing with sick people.
And they have a young son who is starting preschool.
By all accounts, life is pretty good for this couple.
But in the back of their mind: “Wouldn’t it be great if we didn’t have those loan payments? We now have preschool tuition and things would just be a little easier if we could get rid of those loans.”
They have car loans, student loans, and mortgages. No credit card debt.
Using the debt stacking method, they were already going to shorten the time of being in debt from 27 yrs down to just over 20.5 years.
By paying an extra $100/mo, they would shorten the life of the debt to approximately 19 yrs. Good right?
That meant over time they made $22,800 in extra payments (19 yrs times 12 months times $100/mo).
But they only saved $19,000 in interest.
Thus by doing so, they guaranteed themselves a $3,000 loss.
Yes they would have paid off the debt a little sooner, but would you take this deal?
On the other hand, the NH couple I highlighted in this space last week has a different situation. In their case, paying less on debt can be a good thing.
They had credit cards and various loans. And they were paying extra each month on various loans.
Without debt stacking, their payoff time was over 50 years, mostly due to the credit cards and low payments on the student loans.
With debt stacking and the extra principal payment, that time period was shortened to around 30 – 35 years, depending on the order the debt was paid off.
But if you take away the extra principal, and simply use the required or monthly payment (while still using debt stacking), then the payoff time is around 40 years.
Yes, it’s still 40 years – but over 10 years less than they were on schedule for. And with the debt stacking method, they would still pay less in interest over time.
Why would someone pay less on their debt?
Well, all of the pieces of your financial life work together. So if you have very little in emergency savings or other needs, then paying less on your debt so you can build up your savings may be a good idea.
After all, if you have no other cash reserves, then you will add debt again if you incur large expenses or there was some sort of emergency.
Look at your own situation – are you paying more and ultimately costing yourself money? Or are you missing an opportunity to free up cash each month?
Answer to last week’s trivia question – C – 85.5%. According to the IRS study, if people paid what they actually owe, the IRS would have collected an additional $385 billion. How big is that?
Well, in 2005, the Congressional Budget Office projected that the budget deficit in 2006 would be $295 billion – which means that the US would have had a budget surplus that year and reduced some of the overall US debt!
This week’s trivia question – According to the Employee Benefits Research Institute, in 1996, only 1 in 9 American workers believed they would retire after age 65. Today, what is that figure? Is it?
A – 1 in 3
B – 1 in 5
C – 1 in 10
D – 1 in 15
