How Much Should I Spend on Debt Repayment?
27. May, 2009 
7 Comments
Last week I asked how much I should spend on housing. I showed that while I am currently spending about 60% of my income, it is recommend I spend around a third, and my ideal is to be paying around a quarter. What about debt repayment? How much of my net income should I spend on paying down my debts?
Unlike housing costs, where there seems to be a consensus among personal finance experts, debt repayment is a little more contentious. Gail’s budget recommends that around 15% of your net income go to debt repayment. However, as she has said numerous times, you should be putting every single dollar that you can towards debt repayment. The 15% just means that if you are spending more than that, you are WAY too far in debt.
A lot of debt repayment blogs agree with her. You find out your basic needs, and everything else goes to debt repayment.
Dave Ramsey has famously said that you should repay debt with the intensity of a gazelle.
It’s time to think like a gazelle. If you are a gazelle and the marketing and credit card companies are cheetahs, bob and weave and run; do whatever it takes to get away. When you get that new credit card application in the mail – you know, the one that promises low introductory interest rates and lots of bonuses – scream CHEETAH! and destroy it as quickly as you can!
Trent from The Simple Dollar agrees with him, saying:
It was only with that intensity that I was able to hammer away many of my worst habits and actually do the hard work that I needed to do to put my financial life in a better place. For me, day to day life is a series of patterns – and it’s hard work to change those patterns. It was only through serious intensity – yes, I would even call it obsession – that I was able to change a lot of patterns in a reasonably short amount of time.
Without that focus, I would have never found success. I might have been able to keep my head above water – or maybe not. One thing I do know – a leisurely approach to this would not have worked for me.
Other’s disagree, instead saying to “do what works for you”. Some have to throw themselves towards debt repayment – or else they won’t do it at all. Others can slowly work towards changing themselves and their lifestyle, piece by piece, until they are living a frugal and sensible life. Like JD from Get Rich Slowly:
When I was working to pay off my debt, I was not obsessed. I did not give up all luxuries and fun. I was dedicated, yes, but debt reduction did not consume me. For much of those three years, I was struggling to figure things out. I didn’t suddenly move from clueless spender to clued-in saver. It was a gradual process, one that’s not even wholly complete today.
How Much Should I Put Towards Debt Repayment?
Saving For Serenity is about achieving a financial life free from stress or strain. Obviously, having no debt would be a significant stress release! However, I am not willing to sacrifice quality of life to become obsessed with debt repayment. So I suppose I am more like JD, in that I would rather take a little bit longer to become debt free while I slowly make permanent changes to my lifestyle.
In fact, I am going to go even farther than that. I am seeking to create a lifestyle that is financially stable and sustainable, where debt repayment is part of the process, but not the dominant one. It will be one where I will be repaying my debt, at a reasonable rate, without burning myself out trying to push every dollar towards, but still making significant progress towards being debt free.
So what’s the answer? 15% of my net income? That would be about $250 a month, something that will be quite feasible – after the wedding. Should I do more? Should I throw every available dollar at my debt? Would there be a decreasing rate of return on my investment if I were? For example, if I were to pay an extra $50 a month for two years just to reduce my total debt by one month, would it be worth it? How about $25/month for six months? Or $100 for six years? At what point do I draw the line and say that enough is enough?
I ran some numbers just to see what would happen in a few different scenarios. In the first, I wanted to see how much interest rate affected debt repayment.
Assuming the minimum payment was 2% of the loan, graph shows interest rate (%) vs repayment time (months)
Conclusions
This graph shows me that at some point, when it comes to interest rates, you are going to be ahead of the game. When you pay 4 times the minimum payment, you will be overloading the interest, so it doesn’t matter if it is 5, 10, 15, or 20 percent, there’s only so many months before you’ll have it paid off. You will hardly acrue any interest. So obviously it is worth it to pay 4x the minimum, right?
Here’s another way to look at it. When you pay the minimum, the differing interest rates plays a large factor in the time it takes to repay your debt. Once you double the payment, it halves (or more) the repayment time. However, once you triple the payment, you’re not getting the same return. It is aproximately half off of the doubled payment, but for the same amount of money, you’re only recieving half the benefit that you were when you doubled it, in terms of time. When you quadruple it, you’re only recieving an eight of the original benefit (in time) in return for the same amount of money.
For example:
You have a $1000 loan at 15%. The minimum payment is $20. That means you will pay it off in 78 months. If you double payment ($40), you can pay it off in 30 – a savings of 48 months and $372. If you triple it, you can pay it off in 18 months. A savings of 60 months total – but only an additional 12 months and less than $100 in interest. Quadrupling ($80) saves 5 months and about $30.
So is there any point in paying more than double the minimum?
Perhaps it depends on the size of the loan:
Assuming an interest rate of 15%, the graph shows the size of the loan ($) vs repayment time (months)
I created this graph to see what effect the size of the loan would have on repayment time.
The Numbers
Conclusions
Minimum payments on credit cards are usually 2-3% (via Canadian Money Advisor). Using this information, I have concluded that paying back 2% of the original loan, at 15% interest, takes 78 months. If you double that, and pay 4% (2x minimum payment), it drops to 30 months (just 2.5 years). If you double that again, (4x minimum payment), the repayment time drops to 13 months.
So regardless of the size of the loan, if you double the minimum payment, you more than half the length of time it takes to repay your loan, saving you significantly in time and interest charges. How much interest you pay will depend on the size of the loan and the interest rate.
Debt Repayment Plan
My debt repayment plan will be:
Pay 2x the minimum payment on all loans
Pay an additional $x up to 15% of my net income on the highest interest loan
This repayment plan will allow me to double the speed of my debt repayment, half the amount of interest that I pay, without forcing me to go nuts about debt repayment. Yes, being in debt sucks, and yes, I should want to get out as soon as possible – but there is no point in going from one unsustainable life to another. I’d rather create a plan that is realistic, affordable, and will work for the long term.
What do you think? What is your debt repayment plan?
Related posts
- How to Set Up an Online Savings Account
- How to Lower your Debt
- Save Yourself Serious Money by Negotiating - Part 2
- Save Yourself Serious Money by Negotiating - Part 1
- Quickly Calculating Your Net Worth
- Saving While Buying a House
- How Much Should I Spend on Housing?
- Choosing a Good Credit Card
- Maintaining Auto Insurance Rates
- How to Start An Emergency Fund
Matt Goulart
Great discussion and data about payments. I just wish folks would spend this much energy analyzing a purchase before they put it on a card. There are good times to use credit, and bad ones. Most of the card problems I see come from bad decisions in the first place. These types of discussion are helpful, but it’s a little like an attorney trying to get rid of your speeding ticket. The truth is that avoiding the ticket in the first place is the best approach.
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My "purchase" was 4 years of college. Granted, I didn’t spend that much time thinking about it before I did it, but I’m still glad that I did, even though I have loans to pay back now.
I agree though, prevention is key. If I did it again, I would work part time throughout college. I didn’t think there was time then, but I know now that there was more than enough time!
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This is an excellent analysis on debt repayment – very, very good article!
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I put 70% of my income towards debt repayment
I personally can’t see any good reason for not paying off as much as you can as fast as you can.
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This is great information and very helpful for everyone during these hard economic times. The more knowledgeable people are about debt, the easier it will be to manage. Improper debt management results in a bad credit score, which in the long run is more costly. Thank you for your in-depth information, it’s great to read something that isn’t broad.
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Great post , this information is helpful in this time of economic crisis and recession , this leads a path following proper debt management and financial stability , hence i fully appreciate post like these .
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I think your analysis was well done and thoughtful, but I have to ask — what about building an emergency fund? I’ve been reading a few pages that answer "how much should I spend towards paying down debt" and no one seems to consider the need for liquidity.
For example, I have student loan debt (for myself and my husband), and a car loan. I also have credit cards, which I use for almost very purchase I make, but pay in full every month, and never spend on credit cards what I couldn’t pay in cash — I just like the points and ease. Anyway, all in all, I have significant debt, at reasonable interest rates — 2% to 6.5% depending on which loan. Also, some of the debt will become interest free if I go back to school (which I expect to do in 1.5 years).
While considering how much to pay each month, we choose to pay more slowly, and build an emergency fund. We set our goal for savings at monthly expenses X8. These expenses included mandatory bills, such as rent, food, minimums on loans, etc. We made our minimums and saved the rest "just in case." After we had built our savings to our goal, we put what we had been saving into the highest interest loans.
This emergency fund was vital to us because a few months after that, my husband was laid off. We were able to keep paying down our loans, and living basically as as had, until he was able to find a new job. Luckily for us, that was only 3 months, for many in this economy, it’s much longer. Now that he’s working again, we’re replacing what we took out of our savings, (which was actually very little) and will start paying the extra 500 or so a month towards the most expensive loan.
Had we not had that fund, and had to lean on credit cards, for example, to get our monthly needs met, we would have been in big trouble — what good is it to pay down a 5% loan if next month, I have to take out a new loan at 19%??
I would consider all who are looking at how to reasonably pay down debt to consider the need for an Emergency fund and liquidity, especially those with debt other than on credit cards.
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