My boys are really into the Disney Movie Inside Out. If you haven’t seen it yet, I would highly recommend you check it out. One of the stars of the show is Anger. My middle son, Everett, who has 100x the creativity I ever had (or will have), admires this character in the loving way that only a 4 year old can do. A few weeks back, Everett disappeared upstairs for a while only to come down all dressed up as Anger (picture below). He put this costume together all by himself. Pretty good, right?
Do you have an emotional reaction of anger towards the interest you are paying on your debts? I’m not talking about that 0.9% car loan. That might actually make you happy. I’m talking about that credit card at 16% or that student loan at 7%. You should be fired up about the interest you are paying on that loan!
Interest paid on debts is a sure way to halt any progress on achieving financial independence. In fact, it is a great way to go backwards. When it comes to paying interest on your debts, I want you to get angry. After all, this is money being paid to the lender that could otherwise be put towards achieving your other financial goals.
Check this out. The average household is paying a total of $6,658 in credit card debt interest per year. This is 9% of the average household income ($75,591) being spent on credit card debt interest alone. (Reference: Nerdwallet 2015 Credit Survey)
Believe it or not, this statistic is actually worse than it looks. The dollar amount referenced of $6,658 is reported as an average for all US households; including those households that do and do not carry credit card debt. Therefore, when you segment out only those households that carry credit card debt, this figure exceeds $15,000 per year.
While some debt (e.g., new car loans) may carry very low interest rates (aka the cost of borrowing money), that is not the case for credit cards. A quick search on Bankrate.com reveals the average credit card interest rate is currently over 16%.
Think about it this way. Everything you buy with a credit card that you don’t pay off right away you are buying at a premium price when interest is factored into the equation. Kind of ironic considering many people shop for sales and then carry a credit card balance.
Here is an example to see how credit card debt can be a real pain in the butt.
Let’s assume you got sucked into signing up for the Huntington Bank Ohio State Buckeyes credit card. Easy decision, right? After all, the Buckeyes are awesome, you are a Huntington bank member and they were offering 3x rewards. (Please don’t go get this card. I’m being sarcastic.) Over the next year, you manage to rack up a credit card balance of $6,658 (average for the household in the US). If we look at the Card Member Agreement, we see the APR (annual percentage rate) ranges from 13-26% based on the borrower’s credit history. Let’s assume you got an 18% rate.
For this credit card, the monthly minimum payment due is calculated as 2% of the total balance due plus any unpaid minimum payments. So, you get your next credit card bill in the mail and see a minimum payment of $133.16. Not too bad, right? Well, if you only pay the minimum payment from here on out, it will take you 529 months to get rid of this loan and when it’s all said and done, you will have paid out more than $18,000 in interest. That is the negative power of high interest loans.
For those of you that are paying off excessive amounts of student debt at interest rates of 6-8%, you know how painful this can feel. You keep sending in payments and it feels like you are making little to no progress. The key to changing this story is to free up money in your monthly budget that you can put funds directly towards the principal of the loan. You need to punch the principal in the mouth. Seriously… get mad. Once the principal goes down, your amount paid to interest goes down.
How mad should you get? This mad…’tis the season, right?
Your Financial Homework: Those that win financially shift from owing to owning. Working on making this shift already? Keep going and figure out how to accelerate that plan. Haven’t thought about this and/or are numb to the interest rates on your debts? Run some math to see how much you are paying in year per interest and determine how else that money could be used (e.g., saving for retirement, paying off the house, giving it away) to help you get fired up to get rid of it!