Managing Debt

Debt. An ugly word at best. It’s easy to fall into a seemly never-ending cycle of minimum payments and feeling like there’s no way out from under what my wife calls my “boulder”. That’s right, I’ve got debt too, and enough of it to be referred to as a large immovable object.

Let’s walk through “good” debt and “bad” debt. History lesson. Before big banks and local lenders, buying on credit was hard. Some cultures to this day consider debt illegal (there are interesting structures that make it look like debt and smell like debt, but it’s apparently not debt). Purchases were made in cash, and if you didn’t have the dough, you just had to steal it. I mean… wait until you had cash!

Debt today means you can buy and use something now that otherwise you may have needed to wait 10 years to save enough to buy outright. Since banks only need to carry a fraction of their lending balances as collateral, it means they can lend more than they hold. World economies become bigger, cash exchanges hands multiple times. This at a high level is “good”. So what’s bad about debt? Due diligence by banks and lending agencies is often minimal, includes a credit check, verification of income, and you’re sent on your way with a big loan you might not be able to afford. Speaking of affordability, check out my blog on personal budgeting. If you aren’t a finance expert or really good with budgeting, it’s easy to get in over your head. Car loans, student loans, credit card bills, mortgages, personal loans. I bet you currently have several of these types of debt with payments due each month. I do too, I know the pain!

How to Manage Your Debt

If you’re here, you’re asking yourself “how do I reduce my debt”. Here are 4 ways that have worked for me:

1. Figure out your monthly budget and income
   • Read this on budgeting. It’ll help you determine how much monthly debt payments (principal + interest) you can afford.
2. Consolidate and term out student loans
   • Let’s say you have multiple student loans totaling $50k in student loan debt payable at an average of 7% interest over 10 years. That’s $580 a month. Yikes! If that number seems a bit scary, there are ways to reduce your monthly payment.
     • Check whether income-based repayments are an option. The more you make, the more you’ll pay back each month, but when you’re just starting out, this can be a big help.
     • Consolidate your multiple loans into one loan with a longer term of repayment. Maybe that’s 15 years at 8%, but your monthly payment has gone down by over $100 a month, down to $478. When you have the income later, almost all student loans allow additional payments toward the principal balance without any penalty, so you get the best of both worlds. Lower payments initially when you need it, and then you can make an extra $100 payment when you can afford to, to reduce the 15 year repayment down to something smaller close to the original 10 years.
     • Make sure you’re aware of any public service forgiveness options. Generally only applicable to federal loans, not private loans.
3. Reduce your credit card debts
   • Take advantage of 0% interest by transferring your current credit card balance to another credit card. I get these in the mail all the time. It’s a great way to knock down your 20% credit card interest down to 0%. If you have $5,000 in credit card balances at 20%, that’s $1,000 a year you could save in interest alone. Instead of paying interest to the credit card company, you could put that toward lowering your $5,000 balance down to $4,000.
   • Stop using the credit card with the highest interest rate.
   • Call your credit card company and ask for a lower rate.
   • Use a personal loan at a lower interest rate to pay down your credit card balance. I really suggest going through this personal budgeting guide first so you know how much in monthly payments you can afford before taking on a personal loan, but this is a really great option at “forcing” you to pay down your debt. Credit cards have a really low monthly minimum payment which if you pay only the minimum, it could take you 20 years to pay off the balance. A personal loan is usually only a couple years, but if you take that same $5,000 balance on a 3-year loan at 5%, that’s a pretty affordable $150 a month to completely wipe the balance on your credit card now, and pay down that personal loan in 3 years.
   • A bit more painful, stop adding new amounts to your credit card altogether. Lock it away, or even, cut it up if you need to. It can be really hard to pay down a credit card if the balance keeps going up!
4. Shop around
   • For car loans and even mortgages, shop around. This especially applies when you’re first looking. There can be significant differences in the interest rates depending on which lender you choose.

Good luck and stay diligent!