Stop Wasting Money Paying Interest

Interest is an enemy of your wallet.

In no reality that we can think of do interest payments fit into a healthy, frugal, financial lifestyle. This is not to say that it is possible for everyone to avoid paying interest. Nevertheless, it should be a focal point for every financial strategy to minimize or eliminate this withering, wasting enemy to your household.

In some ways, interest could be described as the price of greed, of impatience. The presence of interest almost always means spending above your financial capability. Simply put, we are willing to pay far more for something if we don’t have to pay all at once. We never, however, really see it that way. If you were shown two prices in the store, one cash price and one price after financing and interest, you might decide that the price is just too high. This information is always disclosed to the consumer, but usually well into the purchase process, and tends to be lost in the heat of the buying moment.

Interest is wasted money.

Many readers will be well aware of just how much money is wasted by paying interest, but the goal here at Moneystretching.com is, as always, to get you to think about it just a little bit more. The concept of interest has been with us for about as long as the concept of currency. Paying interest is a consequence of borrowing money. The cost of borrowing that money depends on several factors like credit score, amount borrowed, the length of the loan, and of course the interest rate. It seems that in our society today it is expected and normal to pay interest as a integral part of life. But it doesn’t have to be that way.

Let’s examine interest in a little more detail and see the waste for what it really is. We will start with a simple auto loan, but remember the same principles can apply to mortgages and credit cards. Let’s say you buy a new car for $20000. We will assume average credit, and we’ll ignore taxes and fees. With an interest rate of 4% and a term of 84 months, your monthly payment would be $273.38.

So, for the first four months you are spending and average of $65.75 a month in interest alone. That is the amount of your payment that is going directly to the lender and not applied towards the price of your car. It is not invested and builds no equity. For the borrower, it is wasted. Sure, it could be argued that it is the cost of driving something new that you couldn’t otherwise afford, and that may be worth it to some folks. But it must be pointed out that it is still money going to waste, that could otherwise be saved. As the balance shrinks, so does the amount of your payment that goes to interest. Nevertheless, every single payment includes a portion for interest. Four years into the loan here is your situation:

Now the amount of interest you are paying is much less, but it is a persistent thing. You are still throwing away money each and every month. How much will you have wasted over the life of the loan? Congratulations, you have paid $2964 MORE for your car than the price you thought you were paying. And keep in mind, if your interest rate is greater than the average 4% it could be much more. The cost of financing can be great for those who do not prioritize their credit. A sub-prime interest rate of 12% applied to the same loan would mean a total of $9657 in interest alone, which means a $20000 car cost you $30000.

There are other options that we highly recommend, although for many people circumstances might be different. Nevertheless, the only way to avoid wasting money on a vehicle, or any major expenditure, is to buy in full at time of purchase. If that means driving an older vehicle and pocketing those interest payments each month, so be it. Cars today are viable machines well past the time they are paid for, and maintenance can be allot cheaper than a committed 12 car payments each year.

Develop a strategy to avoid paying interest.

This is where interest control comes into play, and there are a few approaches that can be taken. Let’s dive into analyzing the economics behind a house purchase, and we will begin with another amortization chart. Let’s assume a house price of $350,000 and an interest rate of 4.5%. We will also ignore any taxes, mortgage insurance (assume a conventional loan), or homeowners association fees, and fix the interest rate over a 30 year mortgage:

These numbers are almost painful to look at. Out of a $1773.40 monthly payment, 65% of the first payment goes to purely interest and you build a total equity of $461. For the first 4 months, you will have paid $5240 in interest and only $1854 towards the actual price of the home. The total interest that will be paid is well over $288,000. Considering today’s unstable housing market and inflated rent prices, you can see how the situation may be somewhat unclear for those ready to jump into a mortgage.

Developing a strategy for determining the correct time to pull the pin on a home purchase can be rewarding. Producing a down payment can reduce the amount of interest you pay. But this doesn’t mean that we always recommend a down payment, as this isn’t always the best way to invest cash on hand. That being said, a down payment of $50,000 on our example $350,000 mortgage would save you over $41,000 in interest over the life of the loan. That is greater than an 80% return, but it takes 30 years to completely mature.

For example, adding just $125 per month to your payment will eliminate that same $41,000 in interest. This might very well be obtainable for those who cannot make that initial $50,000 down payment. An extra $200 per month will take over $60,000 of nasty interest away, while pushing it to $300 per month will save you over $81,000 and shorten your mortgage by 25%.

Never carry a balance on a credit card.

At last, we come to the elephant in the room, credit cards and other financing options. Credit cards almost always carry ridiculous interest rates, and carrying a balance is almost never acceptable (read this). Using a credit card is wise in lieu of cash, but only if you use it as cash, specifically cash that you can produce.

Americans owe over $357 billion in credit card balances (according to the Federal Reserve Bank of New York) that are not paid in full every month. This staggering figure produces an enormous amount of wasted money in the form of interest payments each month for millions of Americans. Don’t be one of them.

Our goal is not to scare you into a frugal, interest-free, boring life. But it is our responsibility to get you to hate paying interest as much as possible so that you avoid it at all costs unless it is absolutely necessary. Then, instead of throwing money towards interest every month you can stretch it and get more from every penny you make.

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