If you’ve ever listened to Dave Ramsey before then the title of this post sounds like it goes directly against what he would say. After all if you are struggling and are in such a dire position that you can’t pay all of your bills then this advice is wrong.
But what I’ll be talking about here is not what you should do in that situation but is instead geared toward those of you that are getting up to speed with your budgets. You are feeling good about how it all works and are looking for ways to save. This is one of those ways.
Aside from items such as food or transportation costs, two of the big players in your budget could well be loans and utilities. Lumped in with the utilities are any regular item that makes your life easier whether needed or not. For example:
- Electricity
- Telephone
- Internet service
- Cell phones
- Gas
- Water
- Sewer
- Netflix™
- Audible.com™
- HULU Plus™
Essentially any service for which you owe a monthly bill that is generally due around the same date each month. Loans of course behave in much the same way inasmuch that it’s a set payment and it is due once a month near or about always on the same day every month.
The trick is to understand the difference between the two. On the one hand you have the utilities, they provide a service, metered or not and are more than happy to wait until the actual payment due date in order to recieve the money that you owe. Paying them early is fine but honestly they don’t care and as long as it’s paid on or before the set due date then it won’t affect you (or your credit rating) one iota. The payment amount due is the same whether paid on time or paid early.
Loans however are different, the interest attached to them creeps up with every day. Paying it on the due date is perfectly okay with the lending institution of course but if you can pay it early then you gain.
How?
Easy, allow me to explain.
In most cases loans of all types are compounded daily. The trick then is to pay the loan payments as soon as you can and maintain that pattern which over time can save you a lot of money. Take for example a loan for $10,000 taken out for a period of 4 years. In this example let’s say that the interest rate being charged is 6%.
That being the case then it would breakdown something like this:
- Principal borrowed: $10000
- Monthly Payment: $ 234.85
- Total Interest: $ 1272.81
- Total paid: $11272.81
- Avg Int each Month: $ 26.52
The way to understanding this is to understand how interest is calculated. The formula is generally rate divided by 12 (months in a year) times the principal balance equals interest due. In the very first month of our example loan $50 of the payment would be interest with the remaining $184.85 going to principal. The next month the same formula is applied and the interest charged would be a little less this month at $49.08 paid.
The thing is though, banks and other lending institutions don’t wait until the month is over to calculate the payment, they do it daily. If you take a close look at your paperwork or if you get a statement you will see a daily periodic rate that is simply a fraction of the interest rate being charged. In this case that amount would be around 0.0164%. Now, this may not seem like much but in the early days of your loan it amounts to over a dollar and a half per day. The meter is always running and even though it may not seem like much, knocking down what you have to pay even if only by pennies at a time is worth it and the effort required to do so is minimal.
Your goal then is to make that 0.0164% mean less and less by paying your payments as early as possible each month. When you do so you ultimately pay less over the life of the loan and at the same time you help maintain your good standing as a credit worthy person should that be your goal.
To summarize, if you are operating your budget using YNAB and you have a full buffer in place, then if it near the end of the month and you have most of your paychecks in the bank just waiting to go to work? Then take advantage of your position of being ahead and pay the loan payments due even if the due date is near the end of the next month. Even if over the life of the loan you can’t ever seem to get far enough ahead with your entire budget to pay more than the regular payments, this approach of paying early is nearly equal to paying just one extra payment over the life of the loan which will save you over $100 overall.
Not bad for simply paying loans first and utilities second.