A lot has been written on this
topic already and different people, based on their experiences, knowledge and
observations, have suggested different ways to avoid interest. I will also try
and explain this with an effort to make it more understandable for a common
reader.
Before I start enlisting ways of
how a regular person can try and avoid interest, let’s first talk a little about
why we need to avoid interest and what implications this has on our daily and
financial lives.
As per the definition of Interest
from different sources and combining it into one, easily understandable one, “it
is a claim on your money from someone else who you had borrowed a certain
amount from, had a mortgage from, bought a car etc.”. So when we, let’s say,
buy a car from a dealer and get it financed from a bank or a car financing
company, we agree that we will pay over and above the stated value of that car if
we had bought this on cash. What it means is that we are paying extra for that
car, and similarly, we pay extra for our house that we bought on mortgage, we
pay extra for goods we purchase on credit card and then don’t pay them within
the time period to avoid interest.
So technically, in order to buy
stuff that we can’t actually afford right now, we agree to pay interest. Thus
we add a certain amount to our monthly expenses in terms of interest. If a
normal person’s salary, for example, is $100 and he pays 5-10% interest, the
net salary becomes $90-$95. That person has to then manage his/her expenses
from a lowered salary. If someone is only making a minimum payment (that has a
huge portion of interest and a very small portion of principal amount) this
keeps piling up. Longer you are into paying interest, more you are affecting
your actual net worth.
Of course, being in debt is never
a good feeling and you are under continuous burden of paying it back. Plus, the
same money that you can use somewhere else, you are giving it to another party
just because you could not control your expenses in the past.
Let’s now look at ways of how we
can avoid paying interest:
How to avoid interest on Credit Cards
Credits Cards are one of the
biggest inventions of the modern finance world that have generated these big
institutions huge sums of money. Buy
Now-Pay Later has cursed so many families and individuals. I have seen
individuals with a salary of not more than $1000 and they are spending double
of their income almost every month, just because ‘they think’ they can afford
it. NO!!! It’s not your money, it’s someone else’s money you are using and
those people would not give it to you for free. It’s a consumerism trap. How
comfortable would someone feel if they have to go through the shame of
borrowing money from other people directly and use the same money to buy new
cars, purchase new models of phones etc.!!! So yes, that’s not your money. It’s
a ‘CREDIT’ card.
What you should do is never apply
for a credit card. This will teach you how you can live within your means. This
will make your future more secure and tension free. If, for any reason, you
have to have a Credit Card, do the following to avoid paying interest or any
other charges on that:
-
Apply for a credit card that does not require
annual fee
-
Find out what your statement generation date is.
All the purchases made after the statement generation date will give you a
certain time period i.e. normally 21 days, to make payment and you won’t be
charged interest. But you need to make sure you have cleared your last month’s
balances.
If you have a credit card debt
already:
-
Start with paying the higher interest credit
cards.
-
Always pay more than minimum.
-
Make timely payments.
-
Borrow from someone who won’t charge you
interest and pay off your credit cards.
-
Make a payment plan for yourself to clear off
all your credit card loans. You can create an excel sheet for this.
-
Minimize the number of credit cards you hold by
paying off the rest i.e. start paying off the ones with lower balances first
Since most of the credit cards
charge very high interest, so paying off credit card loans is the first thing
you should take care of.
Start Saving and Investing for your house
I know it seems to be an easy
solution to apply for a mortgage, get the house you want and then pay for that
for the rest of your life. I am sure not many think that how much we are losing
in terms of interest we pay for the mortgage. Let’s say you have agreed to pay
3% annual interest on your mortgage (It’s usually more), if you are to pay this
for 25 years the total interest you will be paying is 75%. This means if the
value of your house becomes double in 20-25 years, you have only gained 25%.
When you compare this the increase in inflation over that period of time, you
have gained nothing.
My recommended solution to this
is, rent low for a period of time, invest your money into stocks, commodities
and even if you are earning 4-5% annually, you will be in a position to buy
yourself a house sooner than mortgage (yes, unless you fully pay off, the house
is only partially yours and you lose it if you can’t make mortgage payments for
any reason).
Don’t lease/finance your car, buy used
It’s intimidating to buy a new
car, especially when you can buy it so ‘easily’ by someone else’s money. Only
if that someone else does not charge you interest! But this does not happen in
real world (Not in current high rate times at least). It’s better to save some money and buy yourself a used car that is
good enough for you. I look at this from another angle. You can buy a
reasonable used car with $ 10,000 but for that you will have to wait a while to
save some money. Tough to wait, but worth it. On the other hand, you can buy a
new car right away, easy? Yes! But how much it costs? Let’s say it costs you
$30,000 in total. Which means it will eat away $20,000 extra from your next few
year’s earnings, the money you could have spent on something more important you
or invested somewhere and earn something out of it. So make the right choice
and save your future earnings.
Budget your expenses and income
There are many online
applications available that you can download to your mobile and keep a record
of all your expenses and income. You can even use Excel sheets. This will
ensure you are keeping a track of what you are spending more and can cut on
those expenses. This will also give you a realization that credit card is not
part of your income. It’s a credit that will be a source of future cash
outlays.
Emergency fund
Every month save some money
towards emergency fund. Build it up as much as you can. Most of the time people
use credit cards or other credit lines is because of a situation they had not
thought about. Add a reasonable portion to your emergency fund every month.
Savings = Income – Expenses, Right?
Yes, there are times when your
expenses increase momentarily, or even permanently for different reasons. From
the above equation, if your expenses have increased you should not look at
using credit cards or other credit options because that will ultimately cause a
further increase in expenses in the form of interest. Increase your income by
working part time.
In the end, if you have realized
that you need to get rid of interest, that’s the first biggest step towards the
betterment of your financial situation. You will be able to spend a more
relaxed life and will have more control on it.
