By Laura Laing
Let me see a show of hands—who has debt?
More than likely, you do. Fact is, the cornerstone of many people’s personal finances involves some form of credit. But if you find it overwhelming to manage your debt, there are a few things that you learned in middle and high school that can help.
Yep, the math you may have despised and feared can play a starring role in your personal finances. This may make your palms sweat and heart race, but I promise: it’s not as challenging as you think. Take a look at these common examples.
If you’re buying a home or a car, you will probably take out some sort of loan. And there’s one sure-fire way to reduce your monthly payments up front: a large down payment. That’s because down payments reduce the amount you’ll be borrowing and, in turn, the amount of interest you’ll pay over the life of the loan.
In other words, the larger the down payment, the more money will ultimately stay in your wallet, bank account or investments. The size of that down payment is completely up to you, but a little bit of really simple math can help you plan.
There are two ways of going about this. You can either set a deadline for having that cash on hand, or you can set a monthly amount of savings. And for simplicity’s sake, we’re going to assume here that you’re just putting your money in your mattress. In other words, we’re not considering any interest or profit you could earn if you socked away your savings at a bank or invested in the stock market.
Let’s say you want to have $25,000 on hand by the end of five years. The amount you’ll need to put away each month is $25,000 ÷ 60 or $416.67.
(Where did the 60 come from? 12 x 5, or the number of months in a year multiplied by the number of years.)
Or what if you know you can put away $350 each month? How long would it take you to save $25,000? Easy-peasy: $25,000 ÷ $350 = 71.43 months. In other words, you can reach your goal in just about six years.
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What’s the APR?
The interest rate itself is another way to save money on credit. And trust me, it can be quite a shock to calculate how much you’ll pay in interest over the life of a loan. But lenders don’t necessarily make this easy for us regular folks to understand.
First, a definition: APR is the annual percentage rate of a loan, not the rate you are paying each month. So if your mortgage has an APR of 3.5%, and your loan is compounded monthly, you are actually paying 3.5% ÷ 12 or 0.29% each month.
And that means you can’t just multiply the APR by the amount owed to find the total interest you’ll pay.
Instead, you’ll need a formula—except that you don’t, really. Online calculators can compute this answer for you, lickety split. Just be sure that you input the values—like time period, APR and principal—carefully.
Paying More than the Minimum
Here’s a little secret: creditors make their money by setting minimum payments. But you can reduce your loan much more quickly by paying more than the minimum each month.
Let’s say you owe an even $6,000 on a credit card with 16% APR and your monthly minimum payment is 2.5% of the balance. That translates to a $150 payment in the first month. (Trust me.) If you make a monthly minimum payment each month, you’ll be in the clear in 40 months (or just over three years), right?
Not so fast. Simply dividing the debt by the first minimum monthly payment ($6,000 ÷ $150 = 40 months) won’t cut it. That’s because you’ve ignored the interest and the fact that your minimum payment will go down each month.
Again, an online calculator will help here. If you merely paid the minimum monthly payment on this loan, it would take you a full 254 months to pay it down! But let’s say you can pay $150 each and every month. In that case, you’re looking at 58 months (or almost five years) of payments. Much better.
[Related: To Save or Pay Down Debt? Budget for Both]
Laura Laing is the author of Math for Grownups, a funny and accessible look at how we use math in everyday life. She blogs at www.mathforgrownups.com.