The Effect Of Lower Interest Rates On Your Ability To Get Out Of Debt

Lower interest rates by themselves will not get you out of debt. But by reducing the interest rates you are paying on your debts right now, it is possible to get out of debt much faster, and save yourself a considerable amount in interest charges. Here's how.

The two main ways to accomplish this are:

  1. get a new, lower rate loan or credit card and transfer the balances of your existing debt, or
  2. try and negotiate a lower interest rate with your existing creditors.

An Example Of What You Can Save

Here's a quick example of how much you could save in both time and money by lowering the interest rates on your debts.

Let's assume that you have two credit cards with outstanding balances on them. The first card has a $10,000 balance and an interest rate of 19%. The second card has a balance of $13,000 and an interest rate of 16%. The minimum monthly payment on both cards is equal to 2% of the outstanding balance each month.

The First Card

If you only paid the minimum monthly payment on this card each month, it would take you about 54 years and cost you $35,198 in interest charges before the debt was settled. But, if you maintained a $200 per month payment (2% X $10,000 = $200) towards the debt on this credit card until it was paid off, it would take you 8 years and cost you $9,971 in interest.

The Second Card

By making only the minimum payment on this card each month, it would take 39 years and cost you $24,659 in interest before you paid off the balance. But, if you paid $260 towards the balance on this card each month, you would have it paid off in 7 years and with interest charges of $8,566.

The Totals Of The Two Credit Cards

If you were to pay a total of $460 each month towards both of these credit card balances, you would be out of debt in approximately 7 to 8 years and would have to pay $18,537 in interest charges. Certainly a better scenario than if you just paid the minimum required payments each month, but still a lot of interest and a lot of time. Now let's see what would happen if you were able to get lower interest rates on your debts.

Achieving Lower Interest Rates Through A Debt Consolidation Loan

Now, let's say that you went out and got a new loan (a home equity loan or personal loan) for $23,000 at 7% interest. You used the proceeds to pay off your two credit card balances and then canceled your cards as not to get stuck with even more credit card debt. (You've learned your lesson and you are determined not to let it happen again.) So what would be the effect of this new lower interest rate on the time it would take you to pay off the debt as well as the amount of interest charges it would cost you until the debt was paid off.

If you simply maintained a $460 per month payment (the same monthly amount as you were paying towards the two credit cards) towards the new loan, you would be out of debt in just 5 years and after paying only $4,273 in interest charges. In other words, you would shave about 3 years off the time it would take to get out of debt and save yourself about $14,264 in interest charges. And because you didn't change the size of the monthly payment, we can be confident that these savings in time and interest costs are completely attributable to the lower interest rates.

The key here is continuing to make the same monthly payments. Whatever you do don't get lulled into making smaller payments each month just because you can. This defeats the whole purpose of a debt consolidation loan. In fact what you should do is aim to pay even more each month and get out of debt even faster!