Finance Curriculum

Posts Tagged ‘debt consolidation’

Whenever a new loan is written, there may be origination fees or discount points assessed to the closing costs. In order to understand what they are and how they work, it is first important to understand what a point is. A point is simply 1% of the amount of the loan. So for example, if you borrowed $250,000 on a home loan 1 point would be $2,500. Origination fees usually range between one-half and two points on most loans. While origination fees may be used to pay down the amount of interest that will be tacked on to the loan they may also be in the form of commission for the broker who originated the loan.

Discount points on the other hand will always pay down the interest on the loan so that monthly payments will be less or in order to qualify for the loan under certain situations such as bad credit. Both origination fees and discount points are to be paid at the time of closing on the loan. In the case of mortgage loans, both would be listed on the lender charges portion of the HUD-1 Settlement Statement and that amount is payable at closing along with any other closing costs and down payments as stipulated in the contract.

The same also applies for loans used in debt consolidation circumstances.

This methodology is similar to a snowball rolling down the hill, hence leading to its name. The debt snowball method is a debt reduction strategy in which one starts by paying off debt starting from the lowest amount. Once you pay the least debt then you move to the next smallest amount to be paid and so forth. You are required to list your debts in an ascending order starting with least amount on the top. The debt snowball method is a form of debt management most commonly used to pay off credit card bills. These days it is the primary debt reduction method taught by many financial experts.

Benefits

The main benefit of this method is psychological. By paying off the smaller debts first the number of creditors is decreased leaving you looking at a shorter list of people you owe money to. Another benefit of this method is that by paying off smaller debts the amount per month decreases, allowing you to either save some money or pay off other debts a bit faster.

Methodology

The first step is to list down all your debts in ascending order; starting from the smallest debt to the highest. The interest rate doesn’t matter unless the amount paid is the same, in such cases the amount with a higher interest rate is listed first. Now that the list is prepared you should be prepared to pay off the minimum on every debt every month until the debt is completely paid off. Determine how much extra you can arrange to pay off the smallest debt by cutting off your expenses. You will have extra cash after you pay one of your debts. Now you will have more cash to pay off the next smallest debt and this goes on to the very top. The next section will explain that. This will go on until all your debts are paid.

Example

A person has the following amount of debts. He also has an additional £100 in hand after paying all minimums every month.

• Credit Card – £150 balance – £25/month minimum
• Car Loan – £2000 balance – £100/month minimum
• House Loan – £5000 balance – £200/month minimum
• After 2 months he would have completed payment of the credit card. Then he would be left with the following two:
• Car Loan – £1800 balance – £100/month minimum
• House Loan – £4600 balance – £200/month minimum

Now he can pay an extra £125 for the car loan every month. After 8 more months he would have completely paid off the car loan. Then all he would be left with would be the house loan which in 8 months would have been down to £3000. Now with an extra £225 a month he would be able to pay off his remaining debt in about 7 more months. And there you have it in 15 months the guy is debt free.

Drawback
The debt snowball method is only effective when you have a high enough income to pay off the minimum on your debts every month. However most people in debt cannot afford such amount of cash and this method would be a failure for them, even leading to bankruptcy. To make the snowball method effective one can use debt consolidation methods.