Barbara O’Neill, Ph.D., CFP®, Rutgers Cooperative Extension, oneill@aesop.rutgers.edu
The best time to reverse a growing debt problem is before it gets out of hand. Debt problems are easy to spot with indicators such as the number and dollar amount of bills owed to creditors. Is the number of creditors and/or outstanding balances increasing? Are debts consuming a greater share of net income? “Yes” answers to these questions indicate an increasing reliance on the use of credit. Are you consistently paying only the minimum due each month on debts? This, too, can be a critical indicator of financial distress. Carrying large debt balances over long periods of time is expensive. When you pay only the required minimum amount, you are paying high finance charges on the unpaid balance.
Making “power payments” is a way to “fast track” the process of becoming debt free. What are power payments? They are enhanced payments to specific creditors that accelerate the debt repayment process. Here’s how the power payment method works. As soon as a debt is totally repaid, the monthly payment from that account is applied to another debt. For example, if you owe eight creditors and one is repaid, the previous payment to the paid off creditor (e.g., $25 that was being sent to Sears) is added on to the payment sent to one of the remaining seven creditors so that debt repayment is accelerated. That extra $25 that is added on to one of the remaining debts is called a “power payment.”
With the Power payment system (also know as a “snowball” or “fold-down” plan), money from paid off accounts continues to be added to remaining debts at progressively accelerated rates until, eventually, all debts are repaid. The result can be hundreds, even thousands, of dollars saved on interest payments and months or years of earlier repayment. Better still, there is no additional monthly cost to debtors above the current level of monthly debt payments. Thus, the amount spent on debt repayment when a power payment plan begins is the same amount spent when the last creditor is paid off. Only the distribution of the total amount spent on debt repayment among various creditors changes.
A free PowerPay® analysis is available at the Utah State University Web site www.powerpay.org. PowerPay® calculates the fastest time possible to get out of debt and the time and interest saved by following a debt repayment calendar created by the program. PowerPay® is effective for any debtor who can make at least the minimum required payment on all debts. It is even more helpful to debtors who have a little extra each month to devote to debt repayment or those who decide to use windfalls, such as tax refunds, for debt repayment. To do a PowerPay® analysis, you need to first list all your debts with the creditor’s name, total owed, annual percentage rate (APR), and monthly payment amount.
PowerPay® first calculates the repayment time and interest cost if you continue to make payments at current levels without any power payments. It is often shocking to see the interest cost and length of time that it takes to repay debts, especially when only required minimum monthly payments are being made. Below is an example of this first round of PowerPay® analysis that shows the payoff time for each debt, total payoff time, total interest, and total paid:
 Next, PowerPay® calculates the possible savings by using power payments in three different sequences: (1) paying off creditors with the highest interest rate first, (2) paying off creditors with the lowest balance first, or (3) paying off creditors with the shortest term first. Of course, PowerPay® illustrations assume that no additional consumer debt payments are included. If additional debt is incurred, it must be paid for separately. Below is an illustration of the “highest interest rate first” debt repayment scenario. Note that repayment time is shortened by almost 6 years and there is over $12,000 in savings on interest. The total repaid is $33,113.77 versus $45,142.12 if power payments are not made.
The detailed calendar illustrates the amount that should be paid to each creditor until all debts are zeroed out. Similar printouts can be obtained for the lowest balance first sequence and the shortest term first sequence. Generally, starting with power payments on the highest interest rate debt first and working down the list of creditors in descending order by interest rate provides the greatest savings. On the other hand, paying off debts with small balances first provides a psychological boost and the difference in the amount of time and interest savings is often small.
The PowerPay® Web site has many other attractive features. It also allows users to see the time and interest savings that result from optional extra monthly payments (e.g., an extra $25 per month) and optional one-time lump sum payments (e.g., $1,000 from a tax refund or bonus). It can also adjust for varying interest rates on one debt, such as a credit card with “teaser rates” that expire. Additionally, the www.powerpay.org Web site includes a spending plan worksheet, financial calculators, and links to online resources. It also includes a section called PowerSave® that helps users calculate how much money they can accumulate after debt is eliminated and saving and investing become possible.
Want to get out of debt as quickly as possible? PowerPay® your way!
