Debt: the good, the bad, the expensive
Read an interest rate as the price of money, see why the minimum payment keeps a debt alive for years, and choose an order for paying debts off.
Interest rate
The price of using someone else's money, charged as a percentage of what you still owe. It is the only number that tells you how expensive a debt is. The size of the debt tells you how big it feels; the rate tells you what it costs you to carry it.
A rate of 3% a month on 1,000 owed means 30 is added in the first month, before you have paid anything back. Pay less than 30 that month and the debt grows.
The useful question is not good or bad
Cheap, and outlives the loan
A modest rate on something still working for you long after the last instalment: training that raises what you earn, a tool your work depends on, a home you would otherwise be renting. The value is still there when the debt is gone.
Expensive, and already gone
A high rate on something used up quickly: a holiday, meals out, a phone upgrade. In month 14 you are still paying for something you stopped noticing in month 2. Same paperwork, completely different deal.
Check yourself
Omid owes 3,000 on a car loan at 12% a year, and 900 on a card at 60% a year. He says: "The car loan is the problem, it's more than three times bigger." What is wrong with that?
- Nothing: with a balance more than three times larger, the car loan has to be the urgent one
- The card costs him more per year, because its rate is five times the loan's
- Both are equally urgent, because urgency is set by the monthly instalment
- He should pause both and put the money into savings until rates come down
Show the answer
The card costs him more per year, because its rate is five times the loan's
Right. The car loan costs 360 a year to carry (3,000 x 12%). The card costs 540 (900 x 60%). The smaller debt is the more expensive one.
THE TRAP
The minimum payment
A minimum payment is usually set just above the month's interest. Pay exactly that and you stay out of trouble with the lender while the balance hardly moves. Nothing is late, nothing is wrong, and years pass. It is designed to be comfortable, and comfort is what makes it expensive.
The minimum is a floor, not a plan. Any amount you add on top goes straight against the debt itself, because the interest is already covered.
Balance 2,000, rate 3% a month
Paying the 80 minimum
interest in month 1 2,000 x 0.03 = 60
left for the debt 80 - 60 = 20
balance after 1,980
Paying 300 instead
interest in month 1 = 60
left for the debt 300 - 60 = 240
balance after 1,760At 80 a month: about 47 months, roughly 3,750 handed over
At 300 a month: about 8 months, roughly 2,270 handed overSame debt, same rate. An extra 220 a month is the difference between paying back almost double and paying back a little over what you borrowed. 3% a month is used here to keep the arithmetic visible; look up the real rate on your own debts.
Check yourself
Mina pays the minimum on her card on time every month for a whole year. At the end of that year her balance can still be almost exactly what it was at the start.
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True
True. The minimum is set just above the month's interest, so only a sliver of it reaches the balance. Paying on time keeps the lender happy with her; it doesn't shrink the debt, which can outlast the thing she bought by years. Control means the balance going down every month, fast enough that you can name the finish date.
Two orders, both defensible
Highest rate first
Pay the minimum on everything, then put every spare unit on the highest-rate debt until it's gone, then the next highest. This is the cheapest route: you always attack the most expensive money. Its weakness is that if that debt is also the biggest, months pass with nothing visibly finished.
Smallest balance first
Same minimums, but the spare money goes to the smallest balance until it disappears, then the next smallest. It costs a bit more in interest and it buys something real: a debt that ends early. For someone who has given up twice before, a finished debt in month two can be worth the difference.
Reza's three debts, minimums covered on all of them
owed rate/yr cost to carry, a year
Card 800 45% 800 x 0.45 = 360
Shop credit 500 30% 500 x 0.30 = 150
Car loan 3,000 18% 3,000 x 0.18 = 540
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1,050
Where does one extra 100 a month do the most good?
on the card 100 x 45% = 45 a year saved
on the shop credit 100 x 30% = 30
on the car loan 100 x 18% = 18Highest rate first: card -> shop credit -> car loan
Smallest first: shop credit -> card -> car loanThe car loan is by far the biggest debt and by far the cheapest per unit owed. Size tells you how it feels. The rate tells you what it costs.
Check yourself
Negar owes 2,500 at 48% a year and 300 at 22% a year. She has abandoned two previous attempts to clear her debts. Which is the better answer?
- Either can work: the 2,500 costs more to carry, but the 300 ends in a month or two
- Split every spare unit equally between the two, so that both balances shrink at the same time
- Always the 2,500 first, because the cheapest route is the only one that counts
- Neither: she should take one more loan to combine them into a single payment
Show the answer
Either can work: the 2,500 costs more to carry, but the 300 ends in a month or two
Yes. Highest rate first is cheaper and is the default answer. But a plan she abandons saves nothing, and two failed attempts tell you something real about which plan gets finished.
Check yourself
Match each term to what it really means
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- The minimum payment → Mostly interest, so the balance hardly moves
- The interest rate → The price of the money you are using
- Highest rate first → The cheapest order to pay debts off in
- Smallest balance first → The order with an early finish line
- "No interest, twelve instalments" → A cost hidden in the price, a fee or a penalty
Five things to do this week
- Put every debt on one line: who, how much is left, the rate, the minimum. Most people have never seen this list in one place.
- Stop adding while you pay down. Clearing a debt and topping it up in the same month is a treadmill.
- Ask about settling early. Some lenders reduce the total, some charge for it. Ask before you build the plan around it.
- Don't borrow to invest. You take on a certain cost against an uncertain return. Lesson 8 explains why that trade is stacked against you.
- If you cannot make the minimums, talk to the lender early rather than late. Silence is the expensive option.
Lesson recap
- The interest rate is the price of money. Balance x rate tells you what a debt costs you each year.
- A debt's size says how it feels; its rate says what it costs. The smaller debt is often the more expensive one.
- The minimum payment is set just above the month's interest, so it can keep a debt alive for years.
- Highest rate first is the cheapest order; smallest balance first finishes something early. Pick the one you'll actually finish.
- When prices rise fast a fixed-rate debt gets lighter in real terms, but only if your income keeps up.