First Step to Paying off Debt: Understanding Debt Rates

To become financially independent and build wealth, you must pay off debt. You should understand your debt rates, how much debt is owed, and what it costs. Then you can begin to create the most appropriate debt repayment plan.

Pay Off Debt

Step 1: Know How Much Debt You Owe

How much debt do you currently carry? Chances are your actual debt balance is much higher than you think. Many of us significantly underestimate how much debt we have. When calculating your debt, you must include all loans, credit cards, and the total balance per lender. You need to have an accurate overview rather than a vague idea. This will allow you to make a more effective plan.

A good source of information is AnnualCreditReport.com. Start by requesting a credit report from each of the three major bureaus. (It would also be a good time to verify that the information on your credit report is correct.) Create a list of all your open accounts and the corresponding creditor that owns them. You may then either obtain an up-to-date statement or contact the creditors in writing to find out your current balance. Ensure that you also find out payment due dates, interest rates, and minimum payments. Keep all this information in one place.

Warning: be careful to select current open accounts only, to avoid reviving an old, or possibly unenforceable debt. Most debt beyond a certain age may not be collected unless the consumer revives it (for example, resuming repayment). The statute of limitations varies between states, so it is best to consult with your state’s laws on consumer debt.

Step 2: Find out How Much Your Debt Costs You

Interest (debt rate) is the cost of borrowing money. Higher interest means it costs more to pay back the loan. Loans with a low-interest rate and longer repayment term may also be expensive.

Many loans often use compound interest (calculating interest upon interest), which costs more than simple interest. You can double-check how much compounding interest will cost using this compound interest calculator.

Unfortunately, most people look at the monthly payment instead the entire cost of the loan. The result is that they may be in a terrible financial shock.

Let’s say you’re looking to purchase a $30,000 at 4.5% interest to be repaid over 6 years. The monthly payments of $476 seem affordable, but it’ll cost $34,287.90 to pay the debt, $4287.90 of which is interest.

Calculating Debt Rates

It’s best to know how much you’ll pay per month and in total. Once you have this information, you can plan to tackle debt quickly or to leverage debt to your benefit.

If you need help with the numbers, check out our:

Conclusion

The first step in your strategy to pay off debts is knowing the debt rates. Carefully review all the debts you owe to understand how much they would cost and work on a plan to eliminate them.