What is the cost of debt? Debt is defined as a commitment to someone else. The someone could be an individual or an organization such as a bank or company. It is something that one is usually obligated to repay. But debt isn’t always monetary. You may want to repay someone who has helped you in the past. For example, someone gave you a ride to a doctor when you were ill. Now, you help them by giving them a ride to buy groceries because their car is in the shop. Consider this a debt of appreciation, instead of a monetary debt.

Then there’s the kind of debt we are all familiar with, a money debt. You owe money to someone. That makes you a borrower, and the one who gave you the funds, the lender. With this type of debt, there is usually a monthly charge added to your payment called interest. Interest is what the lender is charging you for the privilege of having borrowed money from them.

For example, you have a mortgage. In this example, the interest rate will be 6.25% on a $200,000 loan for 30 years. Your payment on this loan will be $1,231.42 (excluding property taxes and insurance). The first month’s payment will include $189.77 for principle and $1,041.67 for interest. As you make each payment, the interest will decrease, and the principle will increase. For the life of this loan (30 years), if you pay it off, you’ll have paid a total of $443,316.38 in total payments. Of this total, $243,316.38 will be interest payments. Totally, you’ll pay over twice the cost of the house, and almost 122% more just in interest.

The same goes for credit cards. Let’s say you owe $5,000 on your credit card with an interest rate of 25%. Your payment would run about $198/mo. Your total interest on that card after 36 months would be $2,156. Your total cost is $7,156.

Moral of the story:

So, what is the cost debt? It’s either a moral cost or financial obligation. Doing what’s right is always a positive. However, when it comes to the monetary debt, it can be costly as shown above. How can you avoid it? Pay extra towards the principle when you can, and as much extra as possible to pay the debt off sooner. That’s money back in your pocket, not someone else’s for saving or other debt reductions. Think about it!