Episode 104 - The True Cost of Debt: What Borrowing Really Costs You

Debt seems normal—but the real cost is anything but. In this eye-opening episode, Paul breaks down how interest, minimum payments, and long loan terms quietly drain your future and steal opportunities you didn’t even realize you lost. Learn how to see debt for what it truly is, make smarter decisions, and take practical steps toward lasting financial freedom. 

Transcript

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Paul, Welcome to Catholic money talk, where we talk about all things money and finance, and we try to do it through a lens of being Catholic, where our ultimate goal is to one day be in Heaven with the Lord. I am your host. Paul Scarfone, thank you for being here today. Welcome back to Catholic money talk. Today, I want to talk about the true cost of debt. What borrowing really costs you, and we're going to dive into that. But before we do, let's say a prayer in the name of the Father and of the Son and of the Holy Spirit. Amen, Heavenly Father. We thank you for this day. We thank you for all the ways that you love and bless us. Lord, we know that you have an awesome plan for us. Just fill us with your Holy Spirit. Give us a great desire to pursue your will in our lives, Come Holy Spirit. We ask all this in Jesus name, amen, in the name of the Father and of the Son and of the Holy Spirit, Amen. So the true cost of debt? What borrowing really costs you? Wow, that is a mouthful. Well, this is something I talk about a lot, but very clearly it hit me last week when I was teaching the high schoolers and my kids school, the watching their face and the aha moments as we spoke about the full cost of debt, right? The payments, the interest over time, and that doesn't really even factor into the lost opportunities of what we could be doing with that money. So I want to talk about that because the the looks on the faces of those kids told me very clearly that, you know, forget about just teaching personal finance that message the true cost of what debt is right the but what borrowing really costs us is not hammered home enough to most of us and and how do we know that? Well, we know that debt is normal. It's probably one of the most normal things. So here's some stats how the average household has an AV in the US has an average credit card debt, just over $6,000 okay, in the US, the average household debt, and this is all types of debt, is over 100,000 we spoke recently about the car payments, the average car payment in the US, average monthly payment for used cars is$521 for new cars, the average monthly payment is $745 a month. Like these are big, big numbers, and sometimes we just hear those numbers. This is the normal part. We hear those numbers. We look at our income, right? For those people who have debt, they look at their income and they think, can I afford that payment? And that's all they're looking at, right? They're just looking at the payment amount. So the activity I did with the kids the other day was I, we, I give them scenarios, right? So last week, scenario was meet Jose and Sally, and I just give them two different scenarios, basically, word problems. Jose just graduated from college. He makes this much money. He has a car payment, he has a student loan payment. He's looking for a place to rent, build his budget for him, right? And and I give the kids those kind of word problems, because math in life is actually word problems, right? It's real life situations that we have to figure out. And sometimes there's some basic math involved. But the normal part of debt is we look at, oh, can I afford that payment? Right? I've got a friend. They just, I believe they closed on a house today, which is very exciting, you know, they go to the bank, and the bank says you can make a payment up to say, you know, you can borrow money to have a mortgage up to a certain amount of money, and that's based on the mortgage company did math, based on their budget, and what the bank thinks they could afford As a monthly payment and then using the interest rate and stuff you back into how much they could possibly borrow. But as people that are responsible for everything the Lord has given to us, including our money and the ability to earn it right, the Lord asks us to steward these things properly. We don't want to kind of relinquish our decision making to the bank who's trying to sell us a mortgage. Rather, we should calculate how much we think we should spend on our home, and if we're going to get a loan to buy it, then figure out what's a 15 year or 30 year, what's the most reasonable, prudent option so that we're managing our money. Well, and we pray about these things, and we see where the Lord's telling us, it's not just math, right? And the normal part of debt is we want this. Everyone seems to be borrowing. I think it was like 80% of households have debt in the US. That's a variety kind variety of kinds of debt, but the most normal ones outside of a mortgage, are going to be the top three, I would say, are credit card debt, student loans and car payments, right? Those are the the that's like the trifecta of burying yourself under a life of payments. So it's very, very normal. So what we want to understand is how much it actually costs us, not just the monthly payment. And in order to do that, we need to understand how interest works, and then what, what do we need to avoid? And how do we pay these off smartly? So I'm going to just give you quick examples of types of debt, because they're not all the same. First is, and I I know these very well, because when I was at the bank years and years ago, I would sell these right and and I ended up buying a lot of them myself, until I realized this was a terrible plan, and when I learned the right way to do it, I had to stop selling these, and I had to leave banking so I could help people get out from under these. But here's so I know these Well, I used to sell them, right? There's three types of debt. There's revolving debt. Revolving debt is credit cards. It's money that revolve. It's credit that revolves. You use it, you pay it off. It's available again to you, and it's just, it's just kind of goes on forever, right? The interest that you owe on your balance, it compounds daily, right? And with credit cards, you typically have a grace period. So if you pay it off on that first statement when you had just made the purchases, you don't pay any interest. But after that, you know, as soon as you don't pay it all off. It's, it compounds interest daily. And there's no fixed payoff, right? There's no, you know, you get your statement, there's your balance owed, there's, you know, a minimum payment, and you can kind of pay any, any amount within there that you want, and it can drag on forever. So that's revolving debt. Then there's installment loans. Installment loans is, is what we're kind of used to with student loans, car loans, mortgages. It's where you have a fixed payment, and there's a schedule, right? I've got a two year loan, a five year old, a 15 year loan, a 30 year loan. Here's the here's the monthly payments. You kind of know when it'll end right, provided you make all those payments. And then lastly is what I call lines of credit. Now, lines of credit are very similar to revolving debt like a credit card, but lines of credit will typically have some type of expiration. So when I was in banking, I remember selling home equity lines of credit, and it was a line of credit. You could use it, pay it off, use it again, pay it off, and it might be there for 10 years, and then after 10 years, it would turn into an installment. Loan for another 10 years or 20 years, right? Based on whatever balance it was at that expiration. And so, you know, typically, business lines of credit are going to be similar to that. They might have a one year, a five year, a 10 year. They might have clean up periods. There's all these different things that we won't get into but for us, for our conversation today, there's, namely, three types. There's revolving there's installment loans and their lines of credit, and all of these vary in their flexible credit access and the structure of the loan, right? Sometimes it's secured, sometimes it's unsecured. Car Loans are secured by the car. Mortgages secured by your home. Credit cards are unsecured, student loans are unsecured, right? So there's, there's something that is, there's either collateral securing the loan, or there's not, right? So those are just some different types. And so as we look at these different types of debt, there's different interest rates that might be applied to them. You can have fixed interest rates, right? My mortgage is at six and a half percent for 30 years. That's fixed. It's not going to change. Credit card, however, is going to be tied to some burial could be prime, prime plus 10, prime plus 18, prime plus 19, whatever those numbers are. Do you have an idea the current prime rate is 7.25 right? And we're not going to get into how that's derived, where it comes from, but the idea is, with variable rates, there's typically some rate that can move and can be changed. Again. We're not going to get into all those different variables of how that would change, but it's a rate that's changed, and then you have some addition or subtraction to it, right? So when I first got into banking, people might have home equity loans, and it might have been prime minus one, right? So that means one full interest point, you know, one full interest you. A percentage below prime, right? You might have prime plus a half, right, which, in this case, 7.25 is prime. If you have prime plus a half, it'd be 7.75 and those rates, those can change. Whenever that primary rate changes, right, you would see a change. Usually you would get a disclosure from your bank within a day or two saying, hey, the effective rate of your new date, because our our prime rate, our primary rate that we're basing this whole loan off of just changed on a fixed loan, you wouldn't have that, right? So I've seen credit cards that are prime plus, you know, 15 prime plus 20. So those rates would be in the 20s, almost 30% right? And those compound Daily. These are annual rates we're talking about. You would just divide that rate by 365 days in a year, and that would tell you how much you have to pay, how fast, how much interest is accumulating every day on the balance that you owe. That's how credit cards work. So so this is a lot of information I'm throwing at you, but so here's how here's how the loan works. Whenever you have a loan, it's a fixed, let's say it's a fixed term. So you have a I'm going to use the student loan example that I used with the kids the other day at school. So imagine this fellow, Jose made up. Made up guy. He is a student loan of 105,000 that's the principal balance. It's a 10 year term, so he has to pay it back with 120 payments, right? One payment every month for the next 10 years. His interest rate is six and a half. So his payment every month, it's 1192 so $1,192 let's just call 1200 his monthly payments, 1200 bucks, when he makes those payments for 120 payments, the amount, hell of paid back. And let's just do this in our head, if it's 1200 a month, and he has 120 payments. The amount of paid back is$144,000 his original balance was 105 so basically, right. So he he's gonna pay 144 but his balance is only 105, that's 39,000 difference. What the heck? Well, that 39,000 is all interest. It's all interest. When I was explaining this to the kids, their eyes like blew up. They're like, Wait a second. So if he only had to pay the 105 back, right? There was no interest on it, but he was, you know, he could, he could save an extra what's, what's the math on that? Almost $400 right, a month would save up to kind of create that, say, $350 a month would create that $39,000 savings he could have had, but it's costing more than that. It's also costing him all of that over 10 years, right, which is a long period of time to be spent paying all that. Right? To give you an example, and this is how amortization works, because the balance is really high at the beginning of the loan, the interest that's accumulated is more so what do I mean by that? So it's 105,000 when his first payment of 1200 bucks, 650 of that, let's say, is principal, the other 550 is interest. Contrast that all the way to his last payment, his last payment of $1,200 about 1180 of that $1,180 of that is principal, and it's only 20 bucks of interest, right? So it's not like a cruel way for the banks to just front load the interest. The truth is, you're paying more interest upfront because you owe more, and as the balance goes down, you pay less and less interest, right? So if you think, if you've had a student loan, and you've gotten a statement at the end of the year, right, because you can tax deduct a student loan interest off your tax return, and you might have had student loans, and you see that that amount gets smaller and smaller every year. I experienced that right? My first year, maybe the the interest that I paid on my student loan was like $2,000 and the next year, it was like 1600 and then 1200 and then 1000 then all of a sudden, it's gone right? And you pay off your student loan. So the faster you pay, the more you pay principal on your loan, the less interest you'll pay. So what do I mean by that you can make your monthly payment of 1200 bucks and then add $500 of a principal payment, right? Principal reduction, and then so in. Instead of only 1200 bucks, let's say you're adding 500 you're actually making $1,700 payment. Well, instead of just 650 going towards interest. Well, now 1200 will go towards interest, or 1150 will go towards interest. And the money you owed that you paid on interest, that first payment, that 550 you still paid that. But the next month that money that it's not going to be 550 anymore. Now it will drop to like 540 right? Because you're paying off more and more principal, and if you just write a check for 105, that first month, that's all it was, right? You didn't have to pay those$39,000 of interest. So that's a loan, and that's how interest works on a loan. Here's here's a crazy one, credit cards. So the example I gave the kids the other day, I told the kids, all right, Jose, he's in a mess. He owes $3,200 on his credit card. He hasn't been able to pay it off. But fortunately, the monthly payment is only $55 that is the minimum payment is only$55 and the kids were building the budget. And then there was, you know, this fellow Jose, had to figure out what he was doing. You know, how much could he afford for an apartment? What should he do? Should he pay more towards the student loan, his car payment. He had the credit card, and so I started showing the amortization that's what this is called. When you kind of look at principal and interest payments over the life of a loan and watch what happens to it every month, I show them the amortization calculator for the credit card. And so the 3200 that he owed his mental his interest rate was 20 and a half percent, which is not terrible, actually for a credit card. His first payment of $55.54 his actual payment was $55.60 5464 right? So about almost all of his payment went towards interest, and 96 cents went to principal. So Jose owed 3200 the first month. The next month, he owed 3199 right. 3199 and the kids were looking at this, realizing, Oh, my goodness, this is going to take him forever to pay it off. And I showed the kids, I ran an amortization calculator. Let's say we wanted, we wanted his $55.60 he was just going to pay that every month. How long will it take him to pay off the credit card balance? It was going to be 20 years, right? So if he just slowly pays that off on the minimum payment that the credit card companies ask him to make, his original balance was 3200 but the total the $55 a month for 240 months, right? 20 years, the total he would have paid back would have been$13,300 That means his 3200 was the principal. That's all he actually used and borrowed, but he ends up paying over $10,000 more in interest, and very quickly, again, I show the kids the calculators. Well, what? What would happen if you didn't have right? So we'll look at Jose with his with his loan, his credit card payment, because that is, you know, $55 a month is not, is not the end of the world as far as a payment. But what if he didn't have that, right? So let's say he doesn't have a credit card instead, he's investing his $55 a month for 20 years. I'm punching this into a calculator right now. If he did that for 20 years, at the end of 20 years, instead of having paid 13,000 to the credit card company, right? Instead of paying $11,000 in interest, if he invested $55 a month for 20 years, he'd have almost $45,000 in his well diversified investment account. That's crazy, right? So the little like the easy cost to kind of get your head around, is this total cost of interest, right? So 3200 turns into over $13,000 of payments back. But if forget that interest he had to pay if he was able to free himself up with that credit card, right? Where the best way to free it up would be, have never gotten a credit card and never racked up credit card debt if he just invested the $55.20 $45,000 let's go the student loan. This was the one that really blows the kids minds, right? Let's just do it for 10 years. So student gets student loan. 105,000 comes out at. At six and a half percent for 10 years, he's got to pay $1,200 a month. So at the end of 10 years, they've paid $143,000 right? 38,000 was interest, but$143,000 well, if he had invested the 1200 and not had a student loan at the end of 10 years, they've got$246,000 that sounds like a very hefty down payment on a house right at 31 or 32 years old, right? And you could probably, let's see. Let me see if this calculator will tell me at at year five and a half, actually, that money gets to about 100 grand, which is not a bad down payment for a house. So this, this is the point that I'm trying to articulate here, that there is such a larger cost than what we're faced with. Right the you go buy a car, and you go to the car dealer, and you say, how much is the car? And they say, oh, it's, you know, I drive by them all the time. The drive by the car dealerships, and I'll see stickers in the cars window. Hey, 399, a month, right? Or really nice looking truck, I'd love to replace my truck, but a really nice looking truck, say, 749 a month. And people think, wow, I make like, six grand a month. So I'll use 749 that makes sense, like I have that available. But they don't step back and look at the big picture, and they say, actually, how much is this really going to cost me? Right? And when you start to do the math, you realize it's 10s of 1000s of dollars more than I ever thought, because you didn't stop and do the math. Now, there's some other challenges too, like I mentioned, credit cards real quick. There's some credit cards that, you know, and I experienced this when I first got a credit card back. Oh, long time. I don't have a credit card for over 10 years now, Taryn and I don't use them. But when I graduated high school, one of the first things I did when I went to college, I got a credit card, and I realized very abruptly, and I was very worried about it, that my minimum payment, that I was making, that I thought I was doing something when I had a balance, the minimum payment wasn't even covering the interest. So what does that mean? Let me give you that credit card example we already had, right if he owed 3200 Jose was 3200 on it, 20.49% interest rate, the interest from that first month is $54 sometimes the credit card companies say, just give us a$30 minimum payment and we'll, we'll, we'll be cool with you. Well, the problem is, you pay them $30 but the interest that month was actually 54 that's $24 of interest that you didn't pay them. They it's called, they capitalize it onto the loan. So instead of your balance going from 3200 and going down because you made a $30 payment, it actually would go up to $3,224 and now the next month, even though you've made a payment, you now owe more than you did because you didn't pay off the full interest that accrued that month. We call in the banking and finance world, we call that negative amortization, or we'll say a negam loan means the balance can actually grow on you if you're not paying the full interest, and you have a credit card, you know, for people you know in your life, maybe you have experienced this, if you've had trouble with credit card debt, and you don't look at it, and you get scared, and you finally, one day say, I got to do something about this. So you look at the state, and you start doing the math, and you're figuring out, what do I actually owe? And you have a panic attack because you owe way more than you ever thought. It's usually because of negative amortization, which, when you signed up for it, you said, Hey, I'm cool with this. I'm totally cool with this. I'm just gonna pay it off every month. I'm not gonna have these problems. Only gonna use it in case of emergency. But then they get you, and they just rake in the money off of you. You've got to be careful for negative amortization loans. You got to avoid those or any situation. I mean, just avoid debt. But if you're trying to pay things off and look at payments. Don't just look at the minimum payment. Look at what are they doing? What are they charging you in interest? Because. You got to pay at least that much every month if you want to see that thing starting to go down all right. Now, here's something else I just want to touch on related to all of this. When when you hear car commercials, or you go to the bank and you get pre approved for a loan, you'll get some type of rate disclosure, and it'll reference APR, annual percentage rate. And here's what that means. That was a way for banks. It was became a regulation that they had to be able to disclose rates based on an annual rate, right? They had to annualize rates to make it easy for consumers to actually see what different loans cost us. Sometimes lenders could add some fees to a loan, which, when you add that in, the interest rates actually looks higher than you thought it was, but that's because they have to add those, some of those fees in to show you the true cost, right? That the APR, so, so this is the total cost of borrowing. Hopefully, this is helpful to you understanding it. There's so many different scenarios you could look at, right, a $30,000 car at 7% for 84 months. That's a car payment of 4450$30,000 car. You end up paying 37,500 for it, right? A mortgage, you get a $350,000 mortgage at 6% on a 30 year loan, the total interest, the total interest you pay back, is 405 the total amount you paid back was 755 that's incredible, right? You the interest cost more than the House did. So reduce these costs, one by not borrowing, but if you've got loans right now, pay them off early. It frees up your cash flow, which just allows you to do other things that you want to do, or that you feel Lord is calling you to do with your money, you're able to be more generous. It gives you more flexibility for future goals. Borrowers slave to the lender in Proverbs, right? It frees you from that. So look at the interest rates on all the debt you have if you're trying to tackle debt right now, take a look at it. Get in there, make sure you're paying all the interest and the principal every month so that you're not having negative amortization loans. Stop using credit card. Stop using that revolving debt. Stop using lines of credit. When you're trying to pay things down. You got a hole and you're trying to dig, dig your way out the bottom. You can't do it. Make extra payments towards principal. Do the Debt Snowball, where you list your debts from smallest to biggest, and you tackle the biggest, the smallest one first, right? You make payments on everything, but you all the extra money throughout the smallest one. First, you get rid of it, and you just everything you're throwing on the small and you throw it the next small, the next biggest, then the next biggest, then the next biggest. So you just have one left. You're throwing everything at it. It's gone. That's what we did to our mortgage. Is gone. Create a date. Do the math. Create a freedom from debt. Date, right? Make a visual payoff timeline. Put it on your fridge, put on your your closet door, whatever it would do to motivate you so debt isn't just a number. It affects your relationships, your marriage. It affects it affects stress, and it has a big impact on your future, hopes and dreams, and it ties your hands up to be able to just go do whatever the Lord's calling you to do because I've said this before. So I talked to friends who are priests, who are in the seminary. Debt is a huge challenge for people pursuing their vocation, whether it be religious life or married life. I talk to young couples that are, you know, waited so long to get married. They're not looking to get married yet, even though they feel called to marriage because they have all the student loan debt. You know, it's a real, real thing. So we need freedom from this debt. So don't borrow. Pay it off as fast as you can. I've got some podcast episodes on paying off debt. You can just go in the search and just do debt pay off, and you'll get a few different things coming up. So I hope this has been helpful. Thank you for joining me today. God bless. Thank you for listening to Catholic money talk. I hope you join us again next time, please click Subscribe on your podcast app to get notified of new episodes. God bless you and have a great day. Foreign.