27 Apr Help! My Line of Credit has Buried Me – Part 2
You’ve used $15,000 of your $20,000 line of credit. The interest rate on your line of credit is 4.5 percent. If you’re Canadian, you’ll pay interest only forever! If you’re American, it’s interest only for the first ten years and if your line of credit is not renewed at the end of ten years, you must pay it off over the next twenty years. Interest rates have been so low for so long, you’ve decided to not worry about. (By the way, this is not an assumption that you should take for granted!)
You figured you would have lot’s of time. Let’s see how this plays out.
Your first month’s payment is just $56.25. That doesn’t seem so bad. Let’s look at the rest of the story. Over the next ten years if you just make interest payments, you’ll pay a total of $6,750 in interest. Paying off the loan over the next twenty years will add another $7,775 in interest. This totals $14,525 in interest. When the line is paid in full, you will pay $29,525. That’s almost double the cost of the initial $15,000 that you borrowed.
I won’t ask how you used the $15,000. Hopefully, it was for an investment that is earning you more than 4.5 percent! If not, that small monthly payment of $56.25 put you to sleep. Your banker is thrilled!
If you manage your line of credit like the bank has taught us, at the end of the first year you will pay $676 in interest. Using CashMap’s strategy, what are the possibilities?
1. Goal: Lower the Balance on Your Line of Credit
ACTION TAKEN – Shift your income to the line of credit but don’t take the initial large withdrawal for an additional payment to your mortgage. Use your mortgage grace period and pay your mortgage on the 15th, pay your remaining living expenses on the 28th of the month and on the 30th make a $300 deposit to savings
IMPACT – At the end of the first month, your interest payment is $41.13. This effectively drops your interest rate to 3.53 percent. Using your positive cash flow, the balance you’ll own on your line of credit by the end of the eleventh month will be $4,362 enabling you to make an additional $1,393 withdrawal for an additional mortgage payment. You’ll spend $206.74 in interest.
INTEREST SAVINGS: $469.34 in savings on your line of credit and $4,962 mortgage interest savings. The one additional mortgage payment of $1,393 enabled you to accelerate four normal mortgage payments.
2. GOAL: Increase Mortgage Interest Savings
ACTION TAKEN: Shift your income to the line of credit and take the initial large withdrawal for an additional payment to your mortgage. Use your mortgage grace period and pay your mortgage on the 15th, pay your remaining living expenses on the 28th of the month and on the 30th make a $300 deposit to savings.
IMPACT: At the end of the first month, you have borrowed an additional $5,200,you’re your interest cost has increased by just $4.38 to $60.63. This effectively drops your interest rate to 3.79 percent. Using your positive cash flow, the balance you’ll own on your line of credit by the year, your balance will have dropped from $15,000 to $12,022. By the 23rd month, your balance will be about $4,700 enabling you to be begin making additional mortgage payments.
INTEREST SAVINGS: $131.24 in savings on your line of credit and $17,425 mortgage interest savings. The one large initial mortgage payment of $5,200 enabled you to accelerate seventeen normal mortgage payments.
Scenario 2 provides the greater savings. However, the first question to ask yourself is which of the scenarios are you most comfortable? If you’re most comfortable quickly reducing the extra debt on your line of credit than scenario one is the right one for you.
What is it that made the difference? You shifted your income to your line of credit enabling you to put your lazy dollars to work 24/7. To squeeze a bit more out of your hard earned dollar by arranging to pay your expenses at the end of your line of credit’s billing period. This lowered your average daily balance creating interest savings. You also stuck to your budget. Congratulations!
A couple of small changes made a big impact to your benefit. Consistently repeating small changes does make a difference!
To review another example with visual aids, read my article, The Usual vs. the Optimized.
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