Interest expenses on debt can erase thousands of dollars away from your bottom line every year. As such, effective debt management is central to the success of any financial plan. With free cash flow, you can spend money to make extra principal payments, which will result in cost savings on your current and future loans. As part of your overall money management strategy, you must learn to properly evaluate interest rates on debt.
Identification
Loan principal describes the amount of money that you have yet to pay off on a particular debt. In exchange for loaning out the principal, your bank will collect interest payments at a certain rate. Interest charges are calculated at either a fixed or variable rate. Fixed-rate loans carry the same interest rate through their term, while variable-rate loans feature interest rates that fluctuate according to the prevailing interest rate environment.
Features
Making extra principal payments on your loan will save you money on interest expenses over time. To determine the amount of cost savings, you can run projections through an online financial calculator. The financial calculator allows you to toggle through regular payment, interest rate, and principal figures, before determining the amount of interest expenses on a particular loan.
Loan Applications
Prospective lenders will evaluate your personal finances, prior to approving a loan principal and setting interest rates. You will be better able to negotiate credit approval on good terms if you demonstrate an ability to make timely payments and manage your debt effectively. Extra principal payments on loans will result in lower balances on outstanding debt, and therefore strengthen the case for your loan application. As part of your loan application, the bank is likely to review your credit report, which documents your debt management history.
Credit Management Strategy
Order a copy of your credit report from Experian, TransUnion or Equifax before making any major purchase that requires debt financing. Once you receive the report, you should verify that the information is correct. Each credit-reporting agency provides online materials to help you dispute potential errors. Next, you can use the credit report to help you list out your outstanding debt balances according to interest rates. To save money, you should make it a priority to pay down your most expensive debt. To do so, you can make minimum payment on low-interest rate debt, in order to preserve cash to aggressively pay off the loan with the highest interest rate.
Investment Strategy
When making investment decisions, you will weigh potential returns against interest rates on your debt. For example, you should spend $5,000 to pay off a credit card that charges a 15 percent interest rate, instead of putting the money into a certificate of deposit that only pays out a 2 percent interest rate. Once your expensive credit card debt is paid off, you may then consider building up your cash reserves alongside a diverse portfolio of stocks and bonds.
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