Paying Down Debt – The Bad News

Especially in these challenging economic times, it's crucial to know the terms of any debts you have incurred. While compounding interest is great for your investments, it could financially destroy you on liabilities.

At first glance, it may seem that a 9% or 12% interest rate isn't all that bad. Intuitively, if debt grows at 9% per year, it seems that it would take about 11 years for that amount to double. The reality is far more sobering though. Use the Rule of 72 to figure out how long it takes for debt to double at a specified interest rate:

72 / interest rate = number of years to double

Using this equation, it only takes about 8 years for a balance to double at a 9% interest rate. And not paying down a $5,000 credit card balance at 12% will result in a $10,000 balance in only 6 years. Unfortunately, with credit card rates often far higher than 12% nowadays, making minimum payments does not put a significant dent in your balance.

Getting on solid financial footing requires discipline and prudent money management. While this may seem quite difficult, it is recommended to set aside a "rainy day" fund that covers at least 3 months of living expenses. Once you're comfortable with the rainy day fund you have established, any additional funds should be used to pay down high-interest debt. This approach entails short-term sacrifice to achieve long-term financial security, but being disciplined enough to follow it will enable you to start building wealth much sooner than you otherwise could.