How interest rates are designed to keep you in debt
How interest rates are designed to keep you in debt
Interest rate is the fixed percentage of a loan that is charged by a lender to the borrowers. The amount of money loaned is called the principal. Usually, interest rates affect the size of each loan; the more the amount, the higher the interest rate and vice versa.
An interest rate can also be described as either the cost of borrowing money or the reward for saving it. The lender calculates it as a percentage of the amount borrowed or saved.
Many people take out loans to finance big and important purchases like a home mortgage or paying for higher education. This isn’t to say that other minor loans can’t be used to purchase luxuries like a car or an appliance. Moneylenders or banks give out sums of money, which tend to incur interest over time. Borrowers are obligated to pay a monetary sum as compensation to the lender for using the funds.
Banks charge slightly varying rates as they are in competition with each other for depositors and borrowers.
How do Interest Rates Work?
Your bank or financial institution adds the interest rate to the total unpaid portion of your loan or credit card balance, and you are obligated to pay at least the interest each compounding period. If you fail to pay the interest rates, your unpaid debt is likely to increase regardless of if you are making payments.
A credit card is issued by a financial institution like a bank allowing the holder to purchase goods on credit, based on the cardholder’s accrued debt. Credit card debt is one of the most common types of debt. Like all other debts, you are charged for borrowing money from a financial institution with your credit card. The interest rate amount depends on the type of card, the transactions you make, and when you make repayments.
How to reduce your interest rate
Here are a few ways you can minimize the interest rates on your debts:
· Do not stall or delay payments. It is best to pay off as much as you can every month and as soon as you can, even before the due date arrives.
· To ensure on-time payments, you can make use of the autopay feature. Card owners can set up monthly, weekly, or bi-annual payments to be deducted from their accounts, which helps ensure that all bills are repaid promptly and in due time.
· Do not go overboard by purchasing things that you can’t afford to pay back.
· You can transfer part or all of your balance into an installment plan to pay off your due periodically.
· Set a spending limit for each month, without permanently decreasing your card limit
· Block ATM cash advances on all your transactions.
Although high-interest rates come with higher loan amounts, they are harder to pay off because the interest increases substantially every month. With high interest rates, if you make only minimum payments, most of it goes toward the interest you owe. Only a small portion goes to reducing your debt.
What to do when you can’t keep up with payments anymore
Here are some tips to consider if you are having problems with repaying your dues:
Late payments
It may seem like bad advice to tell you to make your payments late because it is always good to be on time. However, if you are unable to keep up with early payments, you can consider delaying a bit rather than being very late. Reach out to your lender with a promise to pay within 30 days of the due date. Paying slightly late is not as damaging to your credit score because many of them aren’t reported to credit bureaus. This gives you more time to plan your finances.
Consolidation or refinancing
If paying late doesn’t do much to help your situation, you may want to consider taking out a consolidation loan or refinancing. If you are dealing with toxic loans like credit cards and payday loans, you might be better off with a different loan. Consolidation helps lower interest costs and requires lower payments. Also, taking out a new loan typically gives you more time to repay.
Debt relief
Debt relief, also known as debt cancellation, is when your lender permits a payment reduction or total forgiveness of debt. It can also involve the slowing or stopping of debt growth. Debt reliefs are the steps or measures that are taken to reduce or refinance debt to lessen the financial burden on the borrower.
Debt relief options include:
· Partial or full forgiveness of the debt’s principal also known as debt settlement
· Lowering the interest rate
· Consolidating several debts into a single lower-interest loan
With the help of professionals, you can negotiate with your financial institution to reduce your credit card debt. However, the bank will need proof that you are unable to pay back what you owe. You can only request for forgiveness after you might have skipped several payments, and the creditor believes that you cannot pay the full cost of repayment. By then, your credit score will have been damaged and your income insufficient to pay your bills and debts.
Note that this option is only available for certain types of debts, mostly unsecured debts, such as credit cards. Loans for higher education, mortgage, or cars will not qualify for relief because the properties can be repossessed.
Although requesting a debt settlement may seem like the last resort, it can be the best option for you in the long run. Getting a debt settlement can cause your credit score to drop by about half as many points as a bankruptcy. However, because the post-settlement drop is usually less, it is much easier to rebuild your credit after debt settlement than after bankruptcy. With this option, starting from the very bottom and building your way up can be the best option for you, rather than keeping up with exorbitant interest rates that will eventually damage your credit score.
Debt relief and debt consolidation are often used interchangeably, but they mean different things. Debt relief or settlement helps reduce your total outstanding debt, while debt consolidation helps reduce your total number of creditors.
