If you’re sick of high interest rates, or fearful of how the new laws designed to protect you from yourself will most likely bankrupt you, you’re probably feeling pretty stressed, like I am.
I don’t like having credit card debt, but giving a good vacation to the wife/girlfriend, trying to not have a disappointing Christmas, or buying furniture for that new house usually forces most people to put some amount on the credit cards. Since the credit card companys want you to stay in debt, and have made an entire industry out of doing just that, it’s difficult to get out from under that stress.
I have an idea. Haven’t tried it yet myself, but I wanted to open it to the blogosphere and get some feedback, because technically it makes sense…
Debt (credit cards, loans, bills) is what you owe people, this is negative. Assets (a car you have paid off, stuff you can sell on eBay, money) are what you use to get rid of debt (anti-debt?), which is positive.
Here’s the interesting thing:
The positives can have interest rates (stock market, savings account), but this interest rate is usually small, as in 3% or lower small.
The negatives have larger interest rates, but the range is much larger, from 0% on a new car to 30%+ on a credit card.
There’s nothing we can do about the positive interest rates. We can get better real estate or invest in riskier stocks to try and get more in interest, but we’ll never get to a 30%+ gain per year.
So let’s try to get rid of the high-percentage negative stuff. I’ve already talked about how to get credit card payments cut in half with one phone call, so let’s say out bad interest is in the range of 0%-15%.
An optomistic good interest range is in 5-10%/year, for stocks, real estate, etc. Yes, there are exceptions, but this is an example. Let’s say we’re gaining 10%/year on a $200K house, and 10%/year on $30K of investments. That means our money is making us about $23,000 per year.
However, in the bad interest group, we have 13% on the $5000 of credit card bills, 8% on the $200K mortgage, and depreciation on the paid-off car, currently worth $10K. That means our stuff is costing us $22650.
Overall, our investment gains are being eaten up by our debt interest, so here’s the plan: make the debt’s appetite smaller.
Step 1: sell the car.
It’s going to need maybe a thousand over the next year to keep running properly, compared to a new car? It’s worth 1/3 of what it was when you bought it? It has 60K miles on it? ditch it, we’ll get another one in a bit. in the meantime, borrow a car if you can, or take public transit for the next month while we:
step 2: use the car money to pay off the credit cards
these cards are going to be the end of you. Pay off all the cards, but don’t close the accounts. Just keep paying the $3 monthly fee to keep them open. Credit cards debt goes away, and (after a motnh or two) your credit score skyrockets (once your low balances are reported), which will come in handy next:
step 3: refinance?
now that you have a great credit score, see if you qualify for a lower interest rate on your mortgage. Even 1% can make a world of difference, in this case, about $2000/year. Take your mortgage savings (in this case, maybe about $165/month) and put it towards:
step 4: get a used car
Your old car was used, so you don’t need a new one. besides, the chances are that you can go find a car exactly like yours with half the miles. The good part is that most of a car’s depreciation is in the first few years, so a 2-year-old car will have depreciated to 50% of its original value, but will have only 30K miles, compared to your old car that had 60K miles and was worth 40% of what it was when you bought it. That difference of 10% value only adds up to $2000 on a $20K car, so don’t worry about the cost difference. With your new high credit score, you can get a good car loan, which your mortgage savings help pay for. You can even use any extra money left over from paying off your credit cards to lower the cost of the car, and therefore, the monthly cost. While you’re at it, collect some of that crap that yu haven’t used in years and put it on eBay. After all, you’re not using it, and it’s not going to get more valuable just lying there in your moldy basement.
Your budget for the new (used) car is this: if you are getting a 48-month loan, for example, the total cost of the car + total interest paid (minus savings on mortgage over this period of time)has to be lower than the total cost of paying off your credit cards in 48 months. If the car costs more per month than it would have cost per month to pay off the credit cards in 48 months, you have to find a cheaper car, otherwise there was no sense in doing all of this work, all you did was move your debt from credit cards to a car. (but you did raise your credit score, so a minor kudos to you)
step 5: (optional)
you may want to call it quits right here, but you may want to consider taking what you would have paid to pay off your credit cards over 48 months, and subtracting your step 4 cost (cost of used car over 48 months minus mortgage savings). If this number comes out positive, say, $150/month, that means all of this work has not only paid off your cards and gotten you a better credit score, but lessened your monthly debt. Feel free to put that money towards the house, or more likely, towards that investment fund you had that was making 10%/year.
the end result:
the good
you have no (or lower) credit card debt
you have a better credit score
you have a lower mortgage payment
you have a newer car with less miles, and possibly still under warranty
you are putting more into your investment account
the not-so-good
you had to get rid of your car. get over it.
your new car might have more problems than the last. make sure it has some kind of warranty for the next few years.
you had to be without a car while you waited for your credit score to rise. yeah, that kinda sucked.
you have car payments. yeah, before you didn’t have car payments or credit card payments. That’s because you weren’t paying off your credit cards, which put you in this mess in the first place. So you tell me, car payments at maybe 5%, or credit card payments at 30%?
If you’ve got any ideas or anything to add, please comment!
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