Financial freedom is the dream of many, but the burden of debt often holds individuals back. The real challenge is understanding how to navigate the financial maze effectively. Should you choose amortization to expedite debt elimination, or is investment the route to building wealth?
I’m not an accountant or a financial expert, but the best investment you can make is to free yourself from the shackles of debt – and financing is a form of debt. The problem lies in the exorbitant interest rates associated with financing.
Let’s break it down. Suppose you’ve taken out a financing, approximately $100,000 for 360 installments, which translates to 30 years and each monthly installment is roughly $1,000.
This might leave you wondering, ‘If my monthly installment is $1,000, shouldn’t I pay off my debt in 100 months?’ Unfortunately not, because you’re constantly battling those high-interest rates. When you make that monthly payment, only about $300 goes toward reducing your actual debt, while a whopping $700 vanishes into thin air as interest.
Over the course of 30 years, you’ll find that the $100,000 you initially borrowed will have cost you a staggering $300,000.
So, what’s the secret to getting out of this financial maze?
The answer is: amortization
Amortization is a concept that many people are aware of but often overlook. It’s a way to pay down your debt faster than just making your regular monthly installment. Here’s how you can do it:
- Find Your Amortization Option: Log in to your bank’s app or website, look for your housing or financing account, and search for the option to amortize. Banks don’t always advertise this feature because they want you to remain their debtor for the full term.
- Amortize Your Debt: Amortization allows you to use any extra money you have to pay down your debt. The key here is that you can do this whenever you want, not just when your monthly payment is due.
- Amortization’s Magic: The magic of amortization lies in the fact that every extra dollar you put towards it is worth more than just a regular monthly installment. This is because you’re bypassing those hefty interest rates. For example, if you contribute an additional $1,000 alongside your regular installment, you may not just reduce your debt by one installment but possibly by five or more.
You don’t need to be wealthy to take advantage of this strategy. You just need to be savvy with your finances and allocate your resources wisely. Skip splurging on expensive items like fancy sneakers and focus on what truly matters – eliminating your financing debt.
Here’s a practical example of how you can incorporate amortization into your financial routine:
- Did you receive your annual bonus? Consider putting it toward amortization.
- Are you contemplating selling a high-value asset, like your car? Consider trading it in for something more affordable and put the difference towards your financing.
Even if you apply these techniques for just one year, but consistently, you can reduce the 360-month financing to just 170 months, shaving off 15 years from the repayment period or more.
Do your math. That’s a game-changer!
Now, let’s quickly go over the two amortization options:
- Amortization by Term: This option allows you to eliminate the installments at the end of your financing, reducing the total number of payments you need to make.
- Amortization by Loan: This choice lowers your monthly payments by spreading out the reduced debt over the remaining installments.
Always opt for “Amortization by Term” because it targets the interest you’ll be paying over the entire duration of your financing.
In conclusion, the power of amortization cannot be underestimated. By allocating even modest additional amounts towards paying down your debt, you can significantly accelerate your journey to becoming debt-free. The best part? You’ll save a fortune in interest payments, making it a more profitable venture than many other investments.
Amortization or Investing?
Deciding whether to amortize extra payments towards your debt or invest the extra money is an important financial choice that depends on your individual circumstances, financial goals, and risk tolerance. Here are some key factors to consider when making this decision:
- Interest Rate: Compare the interest rate on your debt to the potential returns from investing. If the debt interest rate is higher, paying it off may be the better option.
- Risk Tolerance: Consider your risk tolerance. If you are risk-averse and prefer a guaranteed return, amortizing debt may be more suitable.
- Financial Goals: Your financial goals play a significant role. If you have high-interest debt, like credit card debt, it’s often wise to prioritize paying it off before investing. If your debt has a low-interest rate, you may have more flexibility to invest.
- Emergency Fund: Ensure you have an adequate emergency fund before investing. An emergency fund provides a financial safety net and prevents you from going into debt for unexpected expenses.
Amortization (Paying Down Debt):
- Guaranteed Return: When you make extra payments towards your debt, you are essentially earning a guaranteed return equal to your loan’s interest rate. For example, if your loan has an interest rate of 5%, paying down the debt is equivalent to earning a 5% return on your investment.
- Risk-Free: Reducing debt is a risk-free strategy. You are certain to save on interest costs and shorten the loan term.
- Psychological Benefits: Eliminating debt can provide a sense of financial security and peace of mind. It can reduce financial stress and free up more of your income for other goals once the debt is paid off.
Investing the Extra Money:
- Higher Potential Returns: Investing the extra money in financial markets, such as stocks and bonds, may potentially offer higher returns compared to the interest rate on your debt. Historically, the stock market has averaged higher returns over the long term.
- Diversification: Investing allows you to diversify your assets and spread risk. Diversification can help you manage risk and reduce the impact of potential market downturns.
- Long-Term Goals: If you have long-term financial goals, such as retirement savings, investing can help you grow your wealth over time. Compound interest can be a powerful tool when investing for the long haul.
Whether you choose to accelerate debt repayment through amortization or embark on an investment journey, the bottom line is that you’re taking a proactive step towards securing your financial future. Be patient and consistent in your efforts, and you’ll see the benefits of your financial wisdom over time.
Striking the right balance between amortization and investing is the key to achieving financial success. Each approach has its advantages, and it’s often wise to use a combination of both strategies to secure your financial future. Keep a keen eye on your financial goals and adjust your plan accordingly to make the most of your resources.
Last but certainly not least, I’d like to highlight this post by Mr. Money Mustache, in which he emphasizes: “Your debt isn’t something you ‘work on.’ It’s a massive, urgent emergency!!!”