Understanding Debt

By personal finance expert and Debt Wise advocate, David Bach

Credit can be convenient, but costly.

Learn when and how to use it.

Get out of Debt Faster With Debt Wise™

Financing is a way of life.

Let’s face it, in the U.S. buying things with credit is as familiar as buying groceries (these days you can even buy food on credit!).

Zero and low interest rate offers, rewards programs and "make no payment for 12 months" can prove irresistible. But watch out – buying with credit is expensive.

“Debt works just like compound interest – in reverse!”

Compounding multiplies the value of your savings the longer your money works. Debt works the exact same way, but in reverse. The longer you take to pay off a purchase, the more you’ll pay in interest. Remember to take financing costs into account when you make a purchase, because financing expenses really add up.

The bottom line is lenders make big money on financing, so of course they want you to use it . . .and the longer you take to pay off your purchase, the more profit they make!

“Minimum payments’ mean maximum expense.”

Make no mistake. Those “minimum payments” suggested by credit card companies aren’t set to help your budget. They’re designed to keep you paying month after month, as long as possible.

Pay the minimum payment suggested by your credit card company, and you could end up shelling out double the price for everything you buy.

“The true cost of long-term financing is mind-blowing.”

Consider this example. You use a credit card to buy a $1000 big screen TV “on sale.” Your card has a reasonable 14% annual interest rate (the most common rate out there as of this writing is 14.5%)

Make only the minimum payments (% of the outstanding balance) and it will take you 159 months to pay off. That’s 13.3 years!

In total, you’ll pay more than $1950 – almost TWICE the TV’s original price. Friends, there are far better ways to channel your resources!

When you absolutely must buy “on time,” ignore that suggested minimum payment. Instead, make the largest monthly payment you can comfortably afford and pay off the debt as soon as you can.

Fixed vs. Revolving Debt

Keep in mind that most credit card debt is “revolving” debt. Because of the way interest is calculated, it’s hard to tell how long it’s going to take to pay off the balance. That’s no accident. The companies know the more confusing they make it, the better (for them, not the customer)!

As you continue to use your card, you add more monthly charges to the balance. The total balance grows, and it gets harder and harder to understand the math. Many people simply give up and make the minimum payment, which as our TV example above proves is a very expensive option.

Fixed or installment loan debt, on the other hand, is much more structured. Payments are set for a fixed amount payable over a specific period of time, and you can easily tell when you will pay off the entire amount you borrowed.

Generally, even with a similar interest rate and monthly payment amount, your pay-off date will be much sooner than with a comparable revolving account. So if you must borrow for a major purchase, an installment loan may be a better option for you than using a credit card.

This chart illustrates the difference:

  Revolving Non-Revolving
Amount borrowed $15,000 $15,000
Interest Rate (APR) 15% 15%
Years to Pay-Off 15 years 3 years
Interest Paid $8,156 $3,674
Total Cost $23,156 $18,674
*Assumes revolving payment (minimum) of 3.5% of the remaining balance or $20, whichever is greater. First month’s payment is shown and term assumed continued payment of minimum amount. No additional debt incurred and payments decrease over time period. **Assumes payment of 3.5% of initial loan amount, no additional debt incurred and payment amount remains fixed throughout the term of the loan. This illustration is hypothetical only. Each debt situation will vary.

“Paying off debt is the best financial move you can make.”

Debt is a major issue for most American families. It’s such an important topic in fact, it’s the focus of my latest book, Debt Free for Life.

Getting your finances and credit score in order is essential before making a major purchase or applying for a mortgage. The less debt you have, and the higher your credit score, the more attractive you’ll appear to potential lenders.

But that’s not the only reason to deal with your debt now. Paying off debt keeps more money in your pocket. That’s because by not paying interest – you’re saving (in effect, “earning”) that rate of return.

With credit card interest rates today ranging from 14% to 22% — or even higher — your savings can add up quickly. In our current economy few investments are offering those rates of return.

That’s one of the reasons I believe so strongly in Debt Wise. It’s an easy way to help yourself get out of debt faster and save money on interest. Just set up your plan and then stick to it. You can do it!

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David Bach finance expert and endorses Debt Wise to help get out of debt faster David Bach, personal finance expert, best-selling author and advocate for Americans getting out of debt faster with Debt Wise.

Learn about budgeting, organize debts and be debt free in David Bach’s Debt Free for Life Debt Wise is feature in David’s new book, Debt Free For Life.

See how easy it can be to organize your debts and start getting your finances back on track. David explains debt – A to Z – in the accessible, no-nonsense style that’s made him a bestselling author for more
than a decade.

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