Debt

Loans and Interest
Being aware of the different types of loans and interest is a crucial part of planning your debt reduction. Some types of loans - such as most mortgages or simple interest loans - are considered "standard" or "acceptable". Other types are designed to appear advantageous to the customer, but may actually be financially dangerous.

These days, it seems that there is a new mortgage type to fit just about anyone's situation. Here is the rundown on some of the more popular mortgages seen today:

• Fixed-Rate: One of the most common and conservative type of mortgages. The rate never changes for the life of the loan. Usually requires a better than average credit score to qualify for lower rates. Being a bit on the conservative side myself, this is what I feel safest with. If you can get a low fixed rate mortgage, grab it.



• Adjustable Rate (ARM): These are often attractive to young and first-time homebuyers. Rates for the first couple of years are very low, making the buyer feel that they can buy more house than they can afford (hence the 2008 crumble of the housing industry). Reality sets in after a few years, when the interest rate rises significantly above standard fixed rates. Unfortunately, many people have lost their homes when they could no longer afford the significantly higher mortgage payment. I could see ARMs being a good idea under two circumstances: a) you know that you're going to sell before the rate gets too high; or b) you plan to refinance within the next couple of years.



• Interest-Only: To me this is simply another lure to get people to qualify for and buy more house than they can afford. As it's name implies, you are required to pay only the interest portion of the loan - making your payment very low. The mortgage broker will typically sell you on the loan by saying "just make some principal payments when you feel like it". Unfortunately, many people shopping for this kind of mortgage don't have the extra money for principal payments. Two problems eventually arise: a) you find that you have little or no equity in the house; and b) the principal is going to be have to paid some time, meaning that your payment will eventually go WAY up.

Credit Card Debt
Credit cards are one of the most convenient purchasing tools available to consumers. When not managed properly, they can quickly become the cause of many consumers' debt and credit problems. The primary reason people get into trouble is that credit cards provide a means of immediate satisfaction, often used to purchase unnecessary items. Soon the balance goes up and the revolving interest starts to really kick in.

Eventually, even the minimum monthly payment is almost out of reach. And that's right where the credit card companies want you - making only the minimum payment. That's how they make their money. Because most of the minimum payment only covers the monthly interest, the principal balance remains high. At this rate it would take you years to pay off the balance. Meanwhile, the credit card company has made thousands in interest.

Getting control of your credit card debt means attacking the issue from different angles:

• Change your spending habits: Stop using your credit cards to buy things you really don't need and can't afford. If you don't have the cash to pay off the card purchase, don't buy it.
• Prioritize your budget: Use any extra money in your budget to pay off the cards as quickly as possible. If necessary, volunteer for overtime or find temporary part-time work to provide extra income.

Mortgage Reduction Tips
The idea of making mortgage payments for 30 years seems daunting to most people. The good news is that it's not necessary. Any extra amount paid toward the principal balance completely changes the amortization schedule. Three popular mortgage reduction methods are:

• Setup automatic additional principal payments. Paying as little as $25 extra per month toward your principal balance will build equity faster, reduce the overall term of the mortgage, and save thousands of dollars in interest over time. Because the mortgage amortization schedule is based on the principal balance, the highest interest amounts are paid at the beginning of the mortgage term. Therefore, extra principal payments made at the beginning of the term will have the greatest effect on reducing your mortgage.


• Make an extra (13th) mortgage payment each year, with the extra payment applied solely to principal.
• If you have the means, you could literally cut your mortgage term in half by paying your normal monthly mortgage payment PLUS the next month's principal payment.

Goal: Becoming Debt Free
There are different philosophies regarding whether to carry a mortgage or not. One view points out the benefit of tax deductions on mortgage interest payments. The other view stresses peace of mind by owning a house free and clear. I look at it this way: who do you think sleeps better at night - a mortgage carrier looking forward to a decent annual tax return, or the person who owns their house outright and is able to invest or save most of their paycheck? Also, who would be more likely to panic if they suddenly found themselves unemployed?

Steps to becoming debt-free:

• Get mentally prepared for a drastic lifestyle change. Becoming debt-free will take sacrifice, focus, and dedication. Watching your debt disappear will keep you motivated. The process may not be fun at first, but the end reward is great. Once you're debt-free you'll never want to be owned by creditors again.


• For one month, write down every dollar you spend. List your expenses by category (i.e., mortgage, utilities, groceries, dining out, entertainment, credit cards, auto loan, insurance, pet expenses, memberships). Then divide the categories into two columns - necessary and unnecessary. Give some serious thought as to what is necessary (mortgage, utilities, car, etc.) and what is unnecessary (boat payment, dining out, etc.). You'll be surprised at how much money you might be throwing away on things that provide immediate (temporary) gratification, but just aren't necessary. How fast you become debt-free will depend on how dedicated you are and how much you're willing to sacrifice.


• Make a list of all outstanding debts from smallest to largest. Also record the interest rate and minimum payment for each debt. Starting thinking about reducing or eliminating items in your "unnecessary" column.


• Cut up your credit cards. If you feel the need, keep one card (with the lowest interest) for emergency purposes only. I keep one credit card, but only carry it with me when traveling. If used for an emergency, pay it off immediately.


• Raise some extra money. Have a garage sale; sell that boat or old motorcycle that sees little use; or even find some extra work. Use this money to start your debt payoff with a boost.


• If you have a mortgage, set up an automatic additional mortgage principal payment. Even small extra principal payments have a snowball effect over time.
  Example: Paying an extra $25 on a $171,000 30-year/6%-fixed mortgage reduces the term by 22 months and saves $14,775 in interest.
  With the mortgage, the idea is to start small just to get the snowball rolling. Once the other smaller debts are paid off, the mortgage will then be the primary focus.

The link below provides various types of mortgage calculators. Enjoy!

Free Mortgage Analyzer