When you make a payment on one of your debts, a portion of your payment goes to your lender (interest portion), and the other portion is applied to your balance owed (principal portion).
Why is it important to know how much of your payment is going to one versus the other? Because one of the keys to getting out of debt and staying out of debt is to become painfully aware of how much your debt is costing you.
What Are Interest Charges Really?
Of course, the obvious answer is the fees that banks charge to lend you money.
Or, one could also define interest charges as money rental fees.
But here is how I like to define personal interest charges:
Now don't get me wrong. I have nothing against the silver spoons of the world. Instead, my definition is simply one that keeps me from buying on credit (for a good visual watch the movie Matrix and view the machines as being corporate lenders).
I don't envy the silver spoons for their inherited mansions, private jets, and luxurious yachts, but I refuse to have their umbilical cords plugged into my wallet.
I encourage you to take some time to develop an interest charge definition that will keep you from buying on credit. Who knows, if you find one that keeps you from buying on credit, perhaps your descendants will be born into wealth.
Track Interest Separately
To accurately track your income and expenses, you should be recording the interest portion of your debt payments to Interest Expense, not to the purchased item's expense category.
In the case of credit cards, you expense the interest charges that are displayed on your monthly statement and then record each charge to their respective expense categories.
For loans (mortgage, auto, personal, etc.) you can use the debt payment calculator to calculate the principal and interest portions of each payment. The principal portion would reduce the amount you owe, and the rest would be recorded to interest expense.
If you continually record interest to its expense account, at the end of every month, you will be able to see how much of your hard earned money is being lost to interest. Most people would be shocked to learn how much of their hard earned income is going to pay the interest charges on their debts.
Pour Some Salt In Your Debt Wounds
If you are having trouble fighting the urge to buy on credit, here are four steps that might help.
1. Visit this calculator each time you make a payment on a debt.
2. When you make the payment, write two checks: one for the principal and one for the interest.
3. Visit the Future Value of Money Calculator and calculate the future value of the interest portion at your retirement age.
4. Using a red ink pen, write the forgone future value of the interest payment into the memo section of your checkbook register.