You can reduce your outstanding debt with just one easy rule. The “Plus 1 Percent Rule” accounts for the monthly interest charged in each payment you make.
Trying to figure out how many payments you have left in your head can be tricky because you debt is still acquiring interest. Also when you just go along paying whatever you feel like is okay, you don’t pay much attention to fee’s and interest being accumulated and it’s very easy to fall into a trap where you pay much more that the amount you planned on.
For a long time my rule was to take the minimum payment then just pay a little extra, basically whatever I felt like I could afford at the time.
I found that my outstanding debts was not going away as fast as I felt like they should be.
Every time I made a payment to reduce my debts I would try and choose a nice rounded number, I would later come back to see that the interest charges would bump the debts back up to a higher level.
So I found a way to get ahead of the interest charges by factoring them into the payment ahead of the charges.
An easy rule of thumb to use is the “+1% Rule“. Take your initial payment and add 1% of the principal.
For this example we’ll assume 12 pct APR
If I owed $7,500 and I wanted next month to show that I only owed $7,000.
Before I was just paying off $500 and feeling pretty good about that payment.
At that rate it would be paid off in 15 months according to the in my head calculations.
However the next month I came back to see it was something more like $7075.
It was kind of discouraging to think I had felt like I just paid off a big chunk, considering the monthly minimum payment is something closer to $300, but I still didn’t hit my goal.
As a matter of fact by only paying the min. $75 goes to the interest and only $225 goes to pay down the principal. That’s 25% of the payment sucked off by interest.
I sat down and looked hard at all the money I was wasting on interest alone and decided to start knocking it out before I even considered how much to pay each month.
So now to keep on the schedule I’ve set, I pay the original $500 + 1% of the total (assuming that nice even 12% APR).
But adding 1% of the total amount you owe to each payment is a good rule of thumb to get ahead on your loans. If you’re paying a higher rate like 30% APR for example then 2.5%. Which is a little harder to do in your head, so just add 1% twice then round up.
How To Add 1 Percent In Your Head:
Adding 1% in your head is easy, just use the 10% rule and knock off an extra 0, and if you can’t figure out 10% of a number in your head then you should turn in all your credit cards, and let your parents, wife, husband, or random middle school student handle your finances from now on.
Instead of $500 now I pay $575.
That way the outstanding total is reduced by the amount I had intended it to.
The good news about this method of payment is that by accounting for the interest in the payment, the amount I pay each month actually gets smalller as I pay it down.
Next time I’ll only owe $7,000 like I intended so I will only have to pay $570 this month. In 5 months I’ll only be paying $550. If you could knock off $25 off your cell phone bill you would consider this a big savings!
This method is helpful if you can afford to pay extra on your debts in the short term and it helps you set a standard for your monthly payment instead of casually paying whatever feels right. It’s also rewarding to see your principal amount go down incrementally in while your monthly payments actually get smaller.
Even if you’ve been stuck paying minimum payments then you should still consider this method, monthly minimum payment + 1% of the total (or your APR / 12 months for higher interest rates ) or else you will never be able to pay it off.
The goal is to pay more today so that down the road your payments will be smaller. If left unchecked you could be paying the same or even more later on due to interest charges.
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