March 29, 2007, 4:24 pm

Example of debt elimination

by: The Financial Blogger    Category: Pay off your Debts
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In the post “Pay Your High Interest Debt first” I was explaining why you should not pay your mortgage first but you should put all your efforts in high interest debt. In order to make your life easier and to understand how by not paying your major debt, you become be debt free, I will explain the technique through an example. In fact, by decreasing your mortgage payment, you will create extra monthly cash flow. Apply this extra cash flow to your highest interest debt in order to pay it off in a timely matter. Here are some figures to show how the whole technique works:

Let’s take the example of David and Tracy, a young couple in their thirties. They bought their house five years ago. At that time, they took a twenty years contract in the amount of $190,000. The property value was $220,000. They wanted to get rid of their mortgage as soon as possible. After five years, their house value increased to $260,000. Therefore, they built $70,000 equity in their home. Here are the details of their debts and monthly payment:

Type of loan

Balance

Minimum Payment

Interest Rate

Mortgage $159 244.74 $ 1 279,50

5,30%

Car lease #1 N/A $ 349,00

8,00%

Car lease #2 N/A $ 390,00

8,50%

Loan (furniture) $ 2 300,00 $ 35,00

14,50%

Visa #1 $ 2 200,00 $ 35,00

17,00%

Visa #2 $ 1 240,00

$ 25,00

19,00%

Mastercard $ 500,00 $ 10,00

18,50%

Americain Express $ 2 800,00 $ 40,00

15,00%

Line of credit $ 8 000,00 $ 60,00

9,00%

Their mortgage is coming to renewal and instead of keeping their existing amortization period, this couple decided to refinance their mortgage over twenty-five years. Therefore, they will pay off their mortgage in thirty years instead of twenty (as they were making their payments for five years already). Actually, they will take less time than that… really? Here’s why:

By refinancing their mortgage, their payment will drop to $953,56. They will then create an extra cash flow in the amount of $325,94 per month. The next step is to apply this extra cash flow plus the minimum required payment to the highest interest debt. Therefore, they will start to pay off their Visa #2 with a 19% interest charge. Every month, they will make a payment in the amount of $350,94 ($25 minimum payment in addition to the $325,94). After less than four months, their Visa will show a 0$ balance. Who’s next? Mastercard!

The payment will increase to $360,94 a month for this one (we take the monthly payment of $350,94 and we add the minimum payment required for the Mastercard; $10). This debt will be paid off within two months only.

Every time one of your debts is paid off, you will free up more cash flow. Always apply your total monthly cash flow on the next debt and you will pay them off in no time. In the present situation, our young couple will take 39 payments to pay off all their credit cards, personal loan and their line of credit. After a little bit more than 3 years, they will be left with a mortgage and two car leases payments. They could also decide to buy off their lease and apply the same technique.

If they decide to keep their car leases, they will still have an extra monthly cash flow of $530,94 (add up all minimum payments in the above chart plus the first $325,94). They could then decide to increase their mortgage payment up to $1810,44 per month! The mortgage would be paid off within nine years. David and Tracy would have taken seventeen (5+3+9) years to pay it down instead of twenty years from their original plan. All this was possible just by changing their debt structure and without taking any risks. I told you, do NOT pay your mortgage!

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Hi FB,

I have been spending some time on your site and felt I should comment on this post. Although this is a good strategy for David and Tracy they would be better served refinancing all of their outstanding debt into their mortgage at the time of renewal.

by: The Financial Blogger | January 19th, 2010 (5:41 am)

Hey No Debt Guy,
Glad you have spent some time here 😉

refinancing would be another great option. It would be interesting to make the exact calculation to know which strategy is best…. time to get back on my Excel Spreadsheet 😉