Get Debt-Free Faster With Automation

An extra house payment here or student loan payment there - savvy moves could shorten your debt repayment timeline by years and save thousands in interest. But, for many, finding room in their budgets for those additional payments can be a challenge.
 
When reducing debt, seemingly minor changes can have an outsized impact on your finances. Strategic use of automated payments can generate extra "found money" each month to turbocharge debt repayment that requires little additional effort or sacrifice. And while you are indeed paying more than the required minimum, the difference may be slight compared to the potential benefits - especially for loans with more extended repayment terms.
 
But what about higher-interest debts like credit cards, personal loans, or home equity credit lines? This is where prioritizing payments comes into play. In this case, it's not just about paying more but about paying smart. By prioritizing payments, you're employing a powerful tactic to reduce your overall interest burden by focusing increased payments on the most costly debt first. 
 
Installment Loans: The Extra Payments Strategy
 
Installment loans are repaid on a fixed timeline with a fixed number of payments. With these loans, the bulk of early payments go towards interest. One strategy to accelerate repayment and reduce interest charges is to pay slightly more than is required each month.
 
With a home mortgage, for example, switching to bi-weekly payments instead of one monthly payment means you'll actually make 13 months' worth of payments per year. But the month-to-month difference to your cash flow is subtle compared to making a full extra payment all at once. On a 30-year $350,000 mortgage at 7% interest, bi-weekly payments pay off the mortgage seven years faster and save over $110,000 in interest. And even if you plan to eventually move to a new home, more than $31,000 of the savings is in the first ten years alone.
 
Those with student loan debt can also benefit from seemingly small changes that can be implemented automatically. For example, for a $30,000 federal student loan with a 4.5% interest rate repaid over a ten-year term, the monthly payment would be $310. By rounding that payment up to the nearest $50 increment, the payment would be $350 per month – just $39 more than the required payment (totaling a little more than one extra payment per year). The monthly difference may not seem like much, but it pays off the loan two years faster and saves over $1,000 in interest.

With both examples, the key is that the extra payments directly reduce the monthly principal balance, so more of your future payments go to principal rather than interest. This cascading effect allows you to pay off loans years ahead of schedule by consistently paying just a little bit more each month. To use this approach, contact your lender to change your payments and to ensure that extra payment amounts are directed toward principal reduction.

The Prioritizing Payments Strategy

When dealing with multiple debts of varying interest rates, prioritizing payments can profoundly impact the total interest paid over time and the time it takes to become debt-free. By structuring your automatic payments to tackle high-interest debts first, you can reduce the overall cost of all your debt.

This approach is often referred to as the "debt avalanche" method. For example, suppose you have $600 per month to apply to reducing debt. If you have a $3,000 balance on a credit card that charges 18% and a $5,000 balance on another card that charges 15%, you would set the automatic payment on the 15% card to the minimum payment (around $100) and set the automatic payment on the 18% card to $500. Once the 18% card is paid off, you then change the automatic payment on the 15% card to $600.

Prioritizing debt repayment with the debt avalanche strategy works best for simple interest loans (like credit cards, personal loans, and perhaps auto and student loans) with higher interest rates. With lower-interest loans, the effect is less dramatic. And there's also the issue of prioritizing debt reduction versus saving for retirement or other goals. In other words, is allocating extra money to reduce interest costs with accelerated repayment worth forgoing potential long-term investment gains? 

The Takeaway

Like any time you set up automatic payments, monitoring your spending is crucial to ensure that there's enough in your account to make the scheduled payments. But automatic payments can be an important part of a well-considered, strategic approach to managing any debt.