How to Become a Smart Borrower: Part 1
1. Borrow for long-term goals, not short-term pleasures. Try to take out loans only for purchases that will pay long-term returns, like a house, a home remodeling, a college education, or a car, and not for a better wardrobe or a European vacation. One useful rule of thumb: Never take out a loan that will last longer than what you’re buying.
2. Apply for the shortest term loan you can afford. Stretch to make the larger monthly payments that come with shortening a loan’s term. By doing so, you’ll pay less in interest over the life of the loan. Consider your choices for a $20,000 car loan at 9.5%. If you select a five-year loan, you’d pay just $420 a month but spend $5,200 on interest, bringing your total payments to $25,200. Opt for a three-year term, however, and although your monthly payments would rise to about $640, you’d pay just $3,060 in total interest or $23,060 in total over three years. By biting the bullet and taking on the higher monthly payment, you could save $2,140 in interest costs.
3. Pay as much as you can up front. When you finance a purchase, put down as much as you can, and don’t go by lenders’ guidelines. Double or triple the minimum down payment the lender demands, if possible. If you can make one or two large payments during the loan’s first months without incurring a prepayment penalty, do it. This strategy, known as front-loading, can shave months off your loan.
4. Consolidate high rate credit card debts with a lower rate card or home equity loan. If you carry a balance on several credit cards, you may be able to merge them into one balance on a single low rate card. Many credit cards will send you a balance transfer form or so-called convenience checks that you can use to pay off your balances on other cards. Be sure to ask your issuer to describe its terms on a balance transfer first: some treat transfers as cash advances and thus may impose a transaction fee of up to $10 or charge higher interest on the amount you transfer.
If your debt is large enough and the rate is low enough, however, you can still come out ahead. For example, if you transfer your $5,000 balance from a card that charges 18% interest to a card that charges 13% interest, you could save $125 in interest over just the first six months. Another option is to scoop up debts into a home-equity loan, assuming you’re a homeowner. Say you’re in the 28% federal income tax bracket and transfer $10,000 from credit cards that charge 18% interest into a 9% home-equity loan. You’ll save about $2,700 in interest payments over five years, plus another $750 or so in federal income taxes, since the home-equity interest is tax-deductible.