Lower Interest Rates and the Power You Just Received

If you are carrying debt with a bank, you were just given a gift (a tremendous gift if you live in the U.S.), because the banks have lower interest rates yet again on loans. What will you do? Will you simply lower your monthly payment to match what the banks ask you and use the extra money elsewhere, or will you exert financial intelligence on this debt and attempt to pay it off faster?

I propose a very pedagogical example for your reading pleasure.

Scenario 1: Original Debt

If you were, say a Financial blogger and say you had $13000 on your line of credit with your banking institution, your payoff schedule for that debt might look like this:

Loan	$13,000.00		Interest	6.500%
Monthly Payment	$398.44		Term of Loan	36 Payments
Date	Payment	Interest	Principal	Balance	Total Interest Paid
01-Jan-08		$13,000.00	$13,000.00	$0.00
1-Feb-08	$398.44	$70.42	$328.02	$12,671.98	$70.42
1-Mar-08	$398.44	$68.64	$329.80	$12,342.18	$139.06
1-Apr-08	$398.44	$66.85	$331.58	$12,010.60	$205.91
etc.,etc.,
1-Nov-10	$398.44	$6.41	$392.03	$790.45	$1,337.31
1-Dec-10	$398.44	$4.28	$394.16	$396.29	$1,341.59

Great easy to understand and see, but wait, the bank just dropped my interest by 1/4 %!!!

New Debt Schedule with Lower Interest Rate

Well how would that look then if I was only paying 6.25%?

Loan	$13,000.00		Interest	6.250%
Monthly Payment	$396.96		Term of Loan	36 Pay’ts
Date	Payment	Interest	Principal	Balance	Total Interest Paid
01-Jan-08		$13,000.00	$13,000.00	$0.00
1-Feb-08	$396.96	$67.71	$329.25	$12,670.75	$67.71
1-Mar-08	$396.96	$65.99	$330.97	$12,339.78	$133.70
1-Apr-08	$396.96	$64.27	$332.69	$12,007.09	$197.97
etc.,etc.,
1-Nov-10	$396.96	$6.14	$390.82	$787.76	$1,284.38
1-Dec-10	$396.96	$4.10	$392.86	$394.29	$1,288.48

That’s kind of cool, I have saved $60 in interest over the length of the 3 year loan, that is nice.

The twist

The twist would be continuing to make the payment I would have made at 6.5%?

Loan	$13,000.00		Interest	6.250%
Monthly Payment	$398.44		Term of Loan	36 Pay’ts
Date	Payment	Interest	Principal	Balance	Total Interest Paid
01-Jan-08		$13,000.00	$13,000.00	$0.00
1-Feb-08	$398.44	$67.71	$330.73	$12,669.27	$67.71
1-Mar-08	$398.44	$65.99	$332.45	$12,336.81	$133.69
1-Apr-08	$398.44	$64.25	$334.19	$12,002.63	$197.95
etc.,etc.,
1-Nov-10	$398.44	$5.86	$392.58	$732.84	$1,279.80
1-Dec-10	$398.44	$3.82	$394.62	$338.22	$1,283.62

So what, I hear you say? Well, I have saved about $5 in interest payments and my last principal payment is about $46 cheaper, so what? Um, that isn’t a good thing, you kept you spent $53.48  and you saved over $60 (or so) over 3 years, but you are paying this debt down faster! If you had put that money in a bank account, would you have got that kind of payback?

Don’t just play with the cards dealt you, if you have budgeted to pay off a loan with a specific payment amount and interest rates drop, then keep up the original payment amount, you will speed up your Debt Pay down!

Interest Rates in 2008

• January 2009 rates were at 1%, money was effectively free.
• October 2008 rates continued to fall, but did we plan accordingly? No, we spent more.
• September 2008 the rates again remained unchanged.
• July 2008 and the rates remained the same.
• June 2008 the rate was 2.75% overnight. Seemed low even then.
• April 2008 another massive rate cut, where could this all lead?
• March 2008 the rates just kept falling, I wonder why?
• December 2007 is when the Christmas presents, like interest rates, kept falling.