What Your Banker Won’t Tell You When Advising You on a Debt Repayment Program
Adopting a debt repayment program obviously makes sense for most of us. We understand that debt is bad and it impedes our ability to save, but what does debt really do to our financial ability to achieve wealth and prosperity? We will take a look a closer look, in dollars and cents, at how debt really impacts our savings rate and makes us poorer.
In keeping with the wealth-building theme, consider the average American who carries roughly twenty-two thousand dollars in credit card debt. At an average rate of 14%, this American pays $3,080 in interest. Getting on to a debt repayment program will allow this average American to chip away at the $3,080 he or she gives to the creditor.
It may seem that $3,080 is not a significant amount of money to pay on annual basis. But if you compound that amount over the course of five years, this seemingly insignificant debt at 14% works out to more than $26,250 that we allowed our creditors to gain. What should really irk us is that, as average every day investors, we can only rarely ever realize the same amount of returns on our investments. Even if we earn an optimistic 10% when we invest our $3,080, compounding our savings over the same period would only give us $23,764, putting us nearly $2,500 behind the big creditors. So a debt repayment program does not help level the playing field.
With the odds stacked in the creditor’s favor when it comes to rates of return, we should take a greater interest in adopting a debt repayment program. Why? Because not only is $23,764 is better than nothing, but it allows us to keep our $3,080 instead of giving it to corporations that enjoy much larger earnings than we do.
To exemplify the matter, let’s assume the average American has an after-tax income of $30,000. By paying an additional $3,080 to creditors, we are giving away more than 10% of our after-tax dollars (this is on top of taxes, insurance, and everything else). Why would we do this when we receive such little benefit in return? It doesn’t make sense. With this in mind, we should take an even greater interest in a debt repayment program, particularly one that will show us what our after-tax dilution rate is and we can reverse that trend.
In terms of improving the cash dilution rate, if the average debtor manages to complete a debt repayment program and starts saving that same $3,080, results will appear rather quickly. After another five years of compounded returns (rather than payments), we will start to see a cash APPRECIATION rate of roughly 8%. This is based only on the interest component (not the actual amount we paid out). Although 8% in our favor doesn’t compare to the 10% dilution when we repaid the debt, we have to remember that the odds are stacked against us. This only underscores the reason for adopting a successful debt repayment plan. And besides, how often does the average American see an 8% raise every year?
To summarize, although most of us understand just how much debt can deteriorate our financial position, few of us care to understand the true impact that debt has on our cash dilution rate. Without such knowledge, the program will likely be inefficient, so take time to review all of the details before committing.
