A lot of people don’t know a lot about personal finance. Even though there are a lot of arguments for introducing a subject that would teach some basic economics concepts from a young age, there’s still nothing implemented from that area.
This makes life quite difficult for the people who decide to start working since they have zero financial literacy. If you’re fresh out of high school, you can go out and get a credit card, max it out during the same day, and then find yourself in debt because the rates are as high as 20 percent. That’s something that everyone should know about.
Additionally, most students that go to college don’t know whether they’ll be able to repay their student loans. A lump sum of 60 grand is a lot for someone who is just finishing their studies, hoping to get a job in their field, and ending up with an entry-level position. Even though there are a lot of advantages when it comes to going to college, the costs and weight of the loans might change a few minds.
Furthermore, there’s the whole issue with living paycheck to paycheck and not having an emergency fund. These basic money principles could save a lot of young people if they knew how to be disciplined with their finances. It’s not surprising that most of them end up in debt, and it takes decades to stand up on their own two feet.
How do people end up in a lot of debt?
The easiest way to end up in debt is ignorance. Going to the bank when you’re 20 seems like a magical place since they can give you a lot of money upfront. You can buy a new car, go on a tropical vacation, or even pay for a wedding and buy everything that you ever wanted.
All of those promises sound amazing, but you don’t know about the hidden drawback that awaits, which is the interest rate. Getting a brand-new car in your 20s is definitely something that you should not do, especially since the depreciation period is instant.
Here’s why. If you buy a car that costs 20 grand and drives it off the parking lot, and you come back to sell it back because you don’t like it anymore, the dealership will offer you 70 percent of what you paid for 15 minutes ago. That’s just how the world works.
A car is something that just takes money from your pocket and burns it. On the other hand, getting a house while you’re still young might be one of the best things you ever do. A mortgage usually takes 30 years to be paid in full.
When you get home early on, you’ll be able to repay it by the time you’re 50, in the worst-case scenario. Plus, as an added bonus, you can do it much faster if you get a couple of promotions on the way and if you know how to refinance. That’s one of the concepts that we’ll go through today, and you’ll see all the ways in which you can save money on interest.
How does interest work?
Whenever you borrow money from a bank, a credit union, or a lending institution, you have to pay it back with a little extra. Here’s one simple example. If you borrow a thousand dollars from your friend immediately, and they do you a favor, you need to pay the favor back.
You can add a ten-dollar bill as a bonus for their immediate service. In this scenario, that’s a 1 percent interest rate on the loan you borrowed from a friend. Banks can either be your friends, or they can be your worst enemies. It all depends on how you interact with them.
Since these institutions have been around for hundreds of years, they’ve seen every trick in the book, and they know a lot about human psychology. If everyone had used banks correctly, then these institutions would have gone bankrupt a long time ago. However, most people are not disciplined with their finances, and all of the interest you’re paying is a source of profit for them.
Here’s a simple refinancing example that shows you how interest increases as time goes by. Let’s say that you want to buy a home that costs 200 000 dollars. At the moment, you can choose a refinansiering plan to repay it anywhere between 10 and 40 years, with 5-year increments between the two. That’s going to be the best choice.
If the interest rate is 6 percent and you choose to repay it in 10 years, then the interest you’ll pay to the bank is 66 000 dollars. That’s the cost for the bank doing you a favor and letting you get the piece of real estate immediately. If you decide to go with the same deal, but the term is set to 15 years, then the total cost of the interest would be 100 000 dollars.
This seems like a lot, but there’s also a massive difference when it comes to the monthly payments. If you decided on a 10-year term, then you would need to pay 2200 dollars each month. Going for a 15-year option decreases that amount to 1600 dollars, leaving you with an extra 600 to invest or use for other purposes.
The interest rate is even bigger if you decide to repay the home for 40 years. Then, the total cost of the interest will be 344 000 dollars. The monthly payments are going to be 1100, which is 500 bucks less than getting it in 15 years.
However, in this case, you’re paying half a million dollars in total for a house that’s worth 200 grand. When you’re doing calculations about which loan to get, make sure to create a table that shows you how much you’re spending on interest.
How does refinancing come into the mix?
Let’s say that you wanted to get a home when you were younger, and you didn’t know that it was a bad deal when you signed it. You got a 200k mortgage over 40 years with a 6 percent interest rate because that made the most sense.
At that time, you didn’t have a high-paying job, and you signed the dotted line. Refinancing as soon as you have a higher income could save you hundreds of thousands of dollars. That’s because the bank looks at your credit score all of the time when they’re trying to make a new deal.
If you were paying everything on time, including your bills, your credit score is definitely going to be quite high. In the eyes of the bank, you’re going to look like a reliable person who is disciplined when it comes to money matters. It’s much more likely that they’re going to give you a lower interest rate, plus a shorter term that will work in your favor.
What are some reasons to go through the process?
Instead of changing only the rate or only the term, you can choose to improve both of them at the same time. Additionally, you can go for a cash-out which is the most famous one. Most of the advertisements that you’ll see will be about a cash-out refinance option.
If you’re in the position to pick, it would be much better to go for the rate and term instead of the cash-out option since the latter needs to be evaluated a lot more. You must make all of the correct decisions when handling loans since going for the wrong deal could lead you into even more debt.
Plus, you need to grasp how pulling your monthly payments will be affected if you decide to take a bit of equity. If you’re going for a cash-out, the first thing you need to be aware of is the use of the cash. Is the point of getting it crucial, or can you live without it?
There are so many causes and reasons, maybe even more than there are stars in the sky. However, deciding to take more value from your home will add to your principal debt, which essentially means more payments. The next thing that happens is the appreciation of real estate. The housing market usually goes up in price.
This will increase the amount that you can borrow, and if you decide on the wrong thing, that could eventually lead you to ruin. However, if used correctly, these types of refinancing can give you a lot of benefits. Let’s say that you’ve got a mortgage, a car loan, and credit card debt. If you decide to borrow against your house and repay the car loan and the credit card debt, you’ll be in a net positive.
Since the 6 percent rate on the house is much lower than the 20 percent on the credit card, you’ve essentially minimized the money you’re paying back in interest. Plus, all of that money is deductible when it comes to taxes, while the credit card interest is not.
