Accelerated Debt Reduction PlansAdvantages, disadvantages; do-it-yourself, and structured plans.

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Accelerated Debt Reduction Plans

Sound debt reduction or debt elimination plans involve one or more of the following three components:

1.Extra principal payments.• Making larger-than-required payments; and/or

• Bi-weekly payment arrangements

2.Paying the highest rate debt first.

3.Reduction of interest rates.(Each of these points will be discussed in detail in the following slides).

Extra Principal payments:Nearly all loans made to Utah consumers allow extra principal payments to be applied to the loan balance, and thus reduce the total amount of interest paid. Before you make extra principal payments, be sure to follow the method prescribed by your lender. Usually that simply means showing the amount of extra principal being paid (the amount in excess of the required payment) in the designated place on the payment coupon or remittance slip. The following is an example of the potential savings.

In this example, if extra principal payments of only $10 are made each month,

10,000 12% 57 mo. 210,000 12% 57 mo. 2332 13,1672 13,167

Loan Rate Term Pmt Total Interest10,000 12% 60 mo. 222 13,346 3,346

If $50 extra principal is paid each month, the borrower pays

10,000 12% 47 mo. 2772 12,582

If $100 extra principal is paid each month, the borrower pays

10,000 12% 38 mo. 3322 12,069 2,069 $1,277 $1,277 less interest, and pays the

loan off almost 2 years early.

Savings

3,167 $179the borrower pays $179 less interest, and pays off the loan about 3 months early.

2,582 $764$764 less interest, and pays the loan off more than a year early

Long-Term LoansThe savings resulting from extra principal payments is even more dramatic for long-term loans such as mortgages. Consider the following example:

136,283 8% 10136,283 8% 101010 29 yr. 29 yr. If $10 extra principal is paid each month

Bal Rate Pmt Term Interest Savings136,283 8% 1000 30 yr. 223,717

136,283 8% 105050 25 yr.If $50 extra principal is paid each month

136,283 7.757.75% 1283 1515 yr. 98,077 $125,640If the borrower can afford $283 extra each month, a 15 year loan can be obtained. Usually 15 year loans can be obtained at a lower interest rate, thus adding to the savings. In this example, if the loan had been obtained at 7.75% rather than 8%, $125,640 less interest would have been paid versus the 30 year loan (assuming each loan was paid according to the schedule shown above).

212,773 $10,944$10,944 less interest is paid, and the loan is paid off about one year early

180,817 $42,900$42,900 less interest is paid, and the loan is paid off about 5 years early

Bi-Weekly (b/w) Payment Programs:A convenient way to make extra principal payments, if:Your paydays are Bi-weeklyYour paydays are Bi-weekly

If you don’t get paid every other week, don’t bother with bi-weekly! (See the following slides).

Your lender accepts extra principalYour lender accepts extra principal (most do without penalty).Reputable money handlerReputable money handler (some have misused funds).

Low or no fees Low or no fees (some lenders charge no fees, some servicers charge high fees).

Warning: many charge periodic service fees and a set-up fee!For some people, a small fee may be worth it for the convenience, and discipline, but watch out!Some servicers claim that the fees come out of the savings. Yes, if you stay with the program,you will save more than the fee they charge, but if you do it yourself, you can avoid the fees and thus save even more.

$ 5 b/w service fee $ 150 setup fee $25 b/w service fee $ 4,0004,000 setup fee

If a person makes 26.09 half

payments bi-weekly in an average year:

The Advantage ofBi-Weekly Payments:

Since there are:

365 1/4 1/4 days in an average year, and

14 days in a biweekly period, there are

== 26.09 bi-weekly periods in an average year.

that is the equivalent of 13.045 full payments in an average year!Most months have 2 bi-weekly paydays, but each year, there will be 2 months with 3 paydays.

About

every 11 years:

*Technical detail: Since there are 26.08929 bi-weekly periods in an average year (365.25 ÷ 14 = 26.08929), about every 11 years, people who get paid bi-weekly, have 3 months with 3 paydays. Since most years have 26 bi-weekly pay periods, we may subtract 26 from 26.08929 to get .08929 as the incomplete portion of a bi-weekly period in an average year. To determine how many years before an extra full bi-weekly period will take place, we may divide 1 (bw pmt) by .08929 = 11.1995 years.

a person paying 1/2 of the regular monthly payment bi-weekly, will make the equivalent of

13 1/2 monthly payments

(by making 27 half payments).

This is because every ~11* years

3 months have 3 paydays.

(3 extra paydays yield 1 ½ extra full payments).

Pay 1.09* x 733.77 = 799.81

Loan Rate Pmt Term Total Paid

Extra Principal Bi-Weekly or Monthly If you don’t get paid bi-weekly, or if you just want to administer your own monthly debt reduction plan and get the same results, you may pay 1.09 times your required monthly payment. If you do, you will obtain almost the same result as paying 1/2 of your monthly payment biweekly.

Bi-weekly: 26.09 half pmts each yr.

733.77 ÷ 2 = 366.89 26.09 times per year

22.65 yrs22.65 yrsthe new term

22.522.5 yrs yrsnew term

48,2048,2099

interest saved (not

paid)

216,832216,832the new total

215,948215,948new total paid

47,3247,3255

less interest paid

Save

66.04 add .09 of a payment each month.

100,000 8% 733.77 mo. 30 yr. 264,157Consider the advantage of paying this loan bi-weekly:

(by paying 17,000 early, you avoid paying $47,325 of interest)

Extra Principal

*1.09 = 1/12 of 13.05 pmts (which is the av. number of full payments made each year in a bi-weekly plan).

Mortgage $ 87,724 734 pmt 8% 20 yrs. remainingCar loan 13,056 415 pmt 9% 3 yrs.Other debts 8,000 203 pmt 18% 5 yrs.Total debt 108,780 1,352

Suppose you were to consolidate these debts into one new mortgage loan; the balance

would immediately go up due to closing costs, but the required monthly payment would

drop. Assuming you could get a better rate, say 7.5% and closing costs of $3,000:

Total Interest

95,0095,0000

If you refinance, but keep paying: 1,352 payoff in 9.75 yrs.Interest & fees

50,00050,000

If you just keep paying

the old debts as agreed:

New loan 111,780 782 new pmt 7.5% new rate 30 yrs. new term

you “save” (delay paying) 493 each month, but do you really save?The total of interest and fees paid (assuming you pay according to the new terms):

There are many who claim that you can

Re-finance and “save”.

If your goal is to reduce your monthly payment, it may work just fine. But if your goal is to get out of debt, or reduce your debt more quickly, if you aren’t careful, refinancing will cause the opposite of what you

intend. Sometimes it works great, especially if you don’t run up other debts again. But often, it just means you are delaying paying, increasing your debt, and greatly increasing the total amount you pay.

Let’s consider the advantages and disadvantages of refinancing the following debts:

Interest & Interest & feesfees

173,00173,0000

50,756 if you keep paying 1352 (no refi) focusing on highest rate debt first.

After 1 year

New New New

Bal. Pmt. Term

77,554 651 21.9

8,072 250 3.1

4,126 150 2.6

6,253 120 8.5

0 0 0

794 90 .8

Getting out of debt quicker, by focusing first on highest rate debts

Let’s suppose someone had

the following debts. They

could meet the payments, but

with no money to spare:

Existing Balance Payment Rate RemainingObligations (p & i*) Term (yrs.)

1st Mort 78,721 651 8.5% 22.9 yrs.

Auto Loan 10,239 250 9.0% 4.1 yrs.

Trailer 5,451 150 9.8% 3.6 yrs.

Credit Card 6,539 120 18.0% 9.5 yrs.

Doctor 400 40 21.0% .9 yrs.

Dentist 1,200 50 19.0% 2.5 yrs.

Totals 102,550 1331 (*p&i stands for principal & interest)

After 1 yr., start applying the amount formerly going to the doctor ($40) to the next highest rate debt (the dentist). After 1.8 years

New New New

Bal. Pmt. Term

76,547 651 21.1

6,194 250 2.3

2,970 150 1.8

5,984 210 3.1

0 0 0

0 0 0

After .8 yr. more, apply the amount formerly going to the doctor ($40) and to the dentist ($50) to the next highest rate debt (the credit card).

After 3.7 years

New New New

Bal. Pmt. Term

73,863 651 19.2

1,153 250 .4

0 0 0

2,745 360 .7

0 0 0

0 0 0

Getting out of debt quicker, by focusing first on highest rate debts

Let’s suppose someone had

the following debts. They

could meet the payments, but

with no money to spare:

Existing Balance Payment Rate RemainingObligations (p & i) Term

1st Mort 78,721 651 8.5% 22.9 yrs.

Auto Loan 10,239 250 9.0% 4.1 yrs.

Trailer 5,451 150 9.8% 3.6 yrs.

Credit Card 6,539 120 18.0% 9.5 yrs.

Doctor 400 40 21.0% .9 yrs.

Dentist 1,200 50 19.0% 2.5 yrs.

Totals 102,550 1331

After 1.9 more yrs, apply the amounts formerly going to the doctor & dentist to the credit card:

After 4.4 years

New New New

Bal. Pmt. Term

72,760 1,261 6.2

0 0 0

0 0 0

0 0 0

0 0 0

0 0 0

Out of debt in 10.2Out of debt in 10.2 yrs.

After .7 yr. more, apply the amounts formerly going to the doctor, the dentist, the credit card, trailer & auto loan to the mortgage loan.

Formal Debt Reduction Programs:

As shown in the earlier slides, you may do your own debt reduction plan by simply adding extra principal to your required payment. In most cases, the more extra you pay, the greater your savings, and the sooner you are out of debt.

If you wish to use a formal plan (maybe because you lack the willpower to do your own, or want the convenience), be cautious:

Formal Debt Reduction Programs:

Remember: Some bi-weekly servicers charge very large set-up fees. Although you will likely save more than the fee - if you stay with the program, such fees still represent money out of your pocket.

Watch out for no-refund clauses (if for some reason you want to get out of the program early).

Formal Debt Reduction Programs:

Also, make sure companies you consider doing business with are reputable money handlers. Many of the programs draft money from your checking account and then make your payment for you. Some have been found to misuse the money. Apparently no regulatory agency oversees such companies.

Dangers Lurking! Each time you refinance, you add to your debt (nearly always).

Be careful that you don’t defeat your intent. There are monsters out there who are more than willing to take as much money as you are willing to give them.

A lady called the Department of Financial Institutions recently who wanted to get a better rate on her mortgage loan. She found out that she’d gotten a very bad deal the last time she refinanced.

She had refinanced her home 2 years prior “because interest rates had gone down.” She thought she was getting the loan terms shown in the left column below. When she went to refinance again, 2 years later “because rates had gone down again,” she found out she actually had the loan in the middle column below. I asked why she signed such a loan, she said she was in a hurry and didn’t read the documents. A very costly mistake! According to my calculations she lost about $24,000 by not paying attention.

Typical

Re-financed $147,000“Closing Costs” $3,000 New Loan $150,000Rate 8%

Diff

$14,000 $3,000

NWFin

Prepay Penalty $0 $7,000 7,000Total Loss $24,000

10%

$147,000 $17,000 $164,000

Variable vs. Fixed RateVariable rate loans can be great if rates go down, but if rates go up, the payments go up, and the total cost of the loan goes up. In a fixed-rate loan, the rate stays the same and the payment stays the same. If rates go down, a person can refinance (if s/he thinks the cost of the refinance is worth the difference in rate). If rates go up in the marketplace, his/her loan is not affected.

Home Loans: Beware

1. Prepayment penalties? Most loans do not have them. Make sure yours doesn’t! Or if it does, make sure you get some benefit in exchange.

2. Compare Rates3. Compare Fees4. Fixed vs. Variable?

Avoid Closing Trapsespecially if delayed

Understand what you are signing and why.

Take your time

Don’t just (sign, sign, sign)

Expect delays, and keep all your other obligations current.Could be the most important 3 hours of your financial life.

Some say: Put your equity to workCompanies keep trying to encourage people

to mortgage their homes and invest the money.

These speculative arrangements have cost many people their homes. Beware!

Even though they promise all sorts of guarantees, too often the investments fail and the borrowers

lose their homes.Don’t risk your home for speculative

investments!

Equity Investments: Suppose a person with plenty of equity

takes out a new mortgage and lets the company “invest it”

0

20000

40000

60000

80000

100000

120000

140000

160000 $150,000 value of $150,000 value of homehome

Existing Existing mortgagemortgage

New mortgageNew mortgageInvestInvest

EquityEquity

(proceeds(proceeds

of loan)of loan)Interest to make Interest to make paymentspayments

Remember:Remember:

EquityEquityHigheHigherrraterate

2. If you can’t afford to lose it, don’t invest it!2. If you can’t afford to lose it, don’t invest it!

1. The greater the rate, the higher the risk! 1. The greater the rate, the higher the risk!

LowLowraterate

Equity Investments

0

20000

40000

60000

80000

100000

120000

140000

160000 $150,000 value of $150,000 value of homehome

Old mortgageOld mortgage

New mortgageNew mortgage

Remember:Remember:

1. The greater the rate, the higher the risk! 1. The greater the rate, the higher the risk! 2. If you can’t afford to lose it, don’t invest it!2. If you can’t afford to lose it, don’t invest it!3. Don’t borrow it if you don’t want to pay it 3. Don’t borrow it if you don’t want to pay it back!back!

Far too many Far too many programs, have lost programs, have lost the investment, the investment, leaving the victim leaving the victim to pay back both to pay back both the old and the new the old and the new mortgage.mortgage.

If you are divorced or getting divorced...

Have you closed out all of your old joint accounts?

If not, you may be liable even if the divorce court directed your x-spouse to pay!

Don’t sign it -unless you agree to it!

How can you agree to it if you don’t understand it?How can you understand it, if you don’t read it?If you still don’t understand it, get some help before signing!!!

For more information,

You may contact the Utah Department of Financial Institutions. 801 538-8830 www.dfi.utah.gov