Loans, instalments and “I lent a friend some money”: how to track debts and see what you really owe

Why a loan payment cannot be recorded as an expense

When you pay the bank five thousand on a loan, that amount holds two different things. Part of it is the return of money you once borrowed: your debt has become that much smaller, and your money has simply moved from one pocket to another — from you to the bank, against the debt. That is not an expense, any more than a transfer between your own cards is. The other part is interest, the price of using someone else’s money. That is an expense, and it is what costs you every month.

If you record the whole five thousand as an expense, the picture breaks in two places. The month’s spending becomes several thousand larger than it really was — and the budget looks hopeless. And the debt shrinks nowhere, because nobody was keeping track of it — and a year later you will not know how much is left without calling the bank.

The right way is to keep the debt separately, as a minus on its own account, and with every payment reduce that minus by the amount repaid, while recording the interest as an expense. Then the month’s spending is honest, and the remaining debt can be seen on any day. How to do that in practice is below.

Make a list of every debt

1. 1Write out the bank loans: consumer loans, a car loan, a mortgage. For each — how much you borrowed, how much is left, at what interest, how much you pay a month and when the last payment is. All of that is in the agreement or in the bank’s app.
2. 2Add the instalment plans: a phone “over 24 months”, appliances “with no overpayment”, furniture. Those are loans too, they just are not called that. Amount, remainder, payment, end date.
3. 3Add the card’s credit limit, if you use it. It is the most often forgotten debt — the next section is about it.
4. 4Add debts to people and debts owed to you: borrowed from your brother, lent to a colleague. Amount, date, what was agreed about paying it back. No interest, but the same honesty.
5. 5Add up the remainders. That is one figure — your total debt today. For most people it turns out larger than they imagined, precisely because of the instalments and the card.
6. 6Add up the monthly payments. That is the second figure — how much of your income is already taken before you have decided anything. Put it in the budget as a compulsory line, next to the rent.

The card’s credit limit is a debt too

The card says “balance three thousand”, and it feels as if you have three thousand. But if the card’s limit is ten thousand and none of the money on it is yours, those three thousand are what you can still borrow from the bank, not what you have. In reality you owe seven. Banking apps show the available amount in big figures and the debt in small ones, and that is not by accident.

So in your records a card with a limit is best kept like this: your own money separately, the debt separately. If none of the money on the card is yours and seven thousand of the limit has been spent, the card’s balance is minus seven thousand. That way it is immediately visible that this is a debt, and it is counted together with the others.

The grace period is a deferral, not the absence of a debt. As long as you return everything by the end of the period, there is no interest, and that is excellent. But the debt is there from day one, and if some month you cannot return it, the interest on a card is the most expensive of anything on your list.

“Zero per cent” instalments, and where the interest is

There is no such thing as free money, and instalments with no overpayment are no exception. The interest is in there, it is just hidden where it cannot be seen on the price tag. Most often — in the price of the goods: the same phone for cash in another shop costs ten to fifteen per cent less, and that difference is your overpayment.

The second place is insurance or a “service fee”, added to the agreement as a separate line and without which the instalment plan “cannot be arranged”. The third is a fee for setting it up or for each monthly payment — small, but multiplied by twenty-four months.

That does not mean instalments are bad. Sometimes they really are worth it, especially when the price is the same as for cash. But to know that, you have to compare the full sum of all the payments with the cash price — and record the difference as the interest you will pay. Then in your records the instalment plan looks like what it is: a loan with a known price.

In what order to pay off

• The most expensive first. The arithmetically correct way: all the free money goes to the debt with the highest interest (usually the card), the rest get the minimum. That way you pay the least interest overall. The downside: if the most expensive debt is also the largest, no result is visible for months, and people give up.
• The smallest first. All the free money goes to the smallest debt by amount, regardless of the interest. A month or two later it is closed, the list is one line shorter, and that visibly adds strength. Arithmetically a little more expensive, but people stick to this plan far more often.
• Both work better than “a bit on each”. Spreading the free money evenly across all the debts is the worst option: none of them closes, interest runs on all of them, and the feeling that nothing is moving is entirely accurate.
• Whichever you choose — the minimum payments on all the other debts, on time. One missed payment costs more than a month of interest, and spoils the history you will later bring to the bank for a mortgage.

Debts between people — write them down at once

You lent a friend two thousand “until payday” — and did not write it down. Six months later you remember two thousand, he remembers one and a half, and both of you are certain. That is not a question of honesty, it is a question of memory: small amounts between people are forgotten faster than anything.

So any debt to a person or from a person, write down the same day: who, how much, when, and how you agreed to pay it back. No interest, no contract — just a line. When part of it is returned, record the return. It is the same mechanism as with a loan: the remaining debt goes down, the spending does not change.

And one more thing: money you have lent is not an expense. It is yours, just temporarily with someone else. Recording it as an expense means lying to yourself that it is gone; not recording it at all means forgetting that it exists. The right way is a separate line: “owed to me”.

Example: a debt that turned out to be twice the size

Andrii believed he had one loan — forty thousand for renovation, paid at three and a half thousand a month. When he made the list, more turned up: a phone on instalments, nine thousand left; a vacuum cleaner “with no overpayment”, four left; the card’s credit limit, of which seven thousand had been spent and which he regarded as “his own money”; and three thousand borrowed from his brother in spring. Altogether — sixty-three thousand instead of forty.

He added up the monthly payments too: three and a half for the loan, one thousand two hundred for the phone, eight hundred for the vacuum cleaner, the minimum payment on the card — about six thousand in all, or a quarter of his income. Before, those six thousand had looked like “spending on the bank” and spoiled the budget every month. Now they are a compulsory line, and only the interest is left in the spending itself: about a thousand a month.

He decided to pay off the smallest first: the vacuum cleaner closed in two months, then his brother, then the phone. The card he stopped using and is paying back within the grace period. A year from now one loan will be left on the list, the same one it all started with — and a figure he knows without a calculator.

How to tell the debts are under control

• You know the total debt without a calculator and without calling the bank. One figure you can name straight away.
• The payment on each debt stands in the budget as a compulsory line, and you are not “looking for the money” for it on the twentieth.
• The share of all debt payments in your income is below thirty to forty per cent. If it is higher — no new debts, even “good” ones, until at least one is closed.
• You can see the remainder going down month by month. If it is not going down, you are paying only the interest, and that needs noticing now, not in a year.
• In FinLad a loan is tied to its own account: a payment is split into repayment and interest, the repayment reduces the debt, the interest goes into spending. The total debt is its own line in the statistics, and a debt to a person is a separate kind of record, with no rate and no schedule. Loans are part of the Plus plan.