Financial literacy doesn’t have to be complicated. Sometimes it’s the simple things that help us manage our money better. Understanding some simple facts about how credit works can help you make better choices about borrowing and debt and help you avoid taking on costly subprime loans.
For example, do you understand amortization periods? That’s a fancy word, but the concept is simple. Amortization simply means the length of time your payments are stretched out to make your loan payments. This is an important concept to understand, so that when the bank asks you “do you want to pay your loan monthly, bi-weekly or weekly?” you will be able to determine the answer that’s best for you.
The correct answer, as I describe in this video on budgeting, is that you should pay your bills as often as you get paid. If you get paid bi-weekly, consider paying your mortgage bi-weekly.
There are advantages to following this type of cycle. Paying bills to match your paycheque makes budgeting very easy, but if you are paid more than once a month, matching your mortgage or car loan payment schedule with your pay schedule will also pay off your loan much sooner.
So instead of paying $1,000 per month on your mortgage you pay $500 every two weeks. In most months there is no difference in your cash flow; you are paying $1,000 per month either way. But making the payments twice monthly will lower your overall interest costs. Even better, in your three pay months, which happens twice a year, you make an extra $500 payment if you are paying bi-weekly. That extra payment will pay off your loan much faster, and you won’t even notice the difference.
That’s a simple example of how understanding how credit works can help you pay off debt years faster.
Here’s another example: it’s not the payment that matters; it’s the total that you pay that’s important.
If you walk into a payday loan store and ask to borrow $500, they say “sure, all you have to pay is $100 in interest and service charges over the next two weeks when you will pay off your loan.” $100 does not seem like a lot, but they are charging you $100 for a two week loan. If you got that same loan every two weeks for a year, you would pay $2,600 in interest and charges. On a $500 loan that’s the equivalent of 520% interest!
If you understand how credit works you will never get a payday loan.