Tackling debt as a “Movement, Health, & Healing Professional” is something that needs to be mastered. No matter where you look, you are very likely to come across a TV headline, journal article, or something else in the media “screaming” about the unwieldy debt issues that consumers face today. Whether it is mortgages (home loans), credit card debt, student loan debt, auto loans, or another type of personal debt, there certainly is something to be said here.
However, instead of pulling out a plethora of statistics on the total amount of consumer debt, the average amount of student loan debt, the growth rate of credit card debt, etc. we wanted to instead give you a few tips on how to think about tackling any debt that you may have.
The Tradeoff Between Paying Down Debt And Investing Money Today
It is very important to have an awareness around the tradeoff between paying down debt (tackling debt) vs. investing your money today. Every single person is going to have a different threshold or risk tolerance of how they think about debt. However, on a general level, one must consider the interest rate being accrued on debt and the potential rate of return that can be obtained when investing the money that would have been used to pay down debt.
This does not mean that one should not pay their monthly required payments on debt, but if you are considering paying down debt faster by going above and beyond on the monthly minimum, you should consider first what you can do with that extra cash.
As an example, let’s say you have student loan debt with a low interest rate of 3.5% with a minimum payment of $300 per month. In this scenario, you also have $700 per month of excess cash flow to be used for whatever you desire. What you would ask yourself, is what should I do with that extra $700 per month? Should I pay more of my debt down per month or is there somewhere else that the $700 can go that will be more helpful?
The answer is going to be different for everyone. If you absolutely hate having any amount of debt, you’re most likely to simply use the extra $700 per month to pay down your student loan debt faster.
However, if you are able to obtain a reasonable rate of return in an investment account, whether it is a taxable account or retirement account (401(k), IRA, Roth IRA, etc.), it may make more sense to use the excess $700 per month towards savings there. By reasonable rate of return, we are talking about 5% – 10%, but most notably in this example, if you are receiving a rate of return greater than 3.5%, you may want to consider investing the money today.
Ultimately this tradeoff is going to be different if the interest rate on your debt is much higher. For example, if you are maintaining a balance on your credit card, with a higher interest rate (APR), it will most likely be the case that you will want to pay down the credit card debt faster with the excess cash flow that you have. Finally, it is going to be important to consider all of the uses of excess cash flow that you have, your overall investment options, the total amount of debt, the different kinds of debt, and your general feelings towards debt.
Tackling Debt – Credit Cards
First, we would like to discuss credit card debt and provide a framework on how to think about the credit cards that you have. This is the easiest form of debt that most consumers can get into trouble and if not fully understood or handled, could lead to excessive interest charges, fees, etc.
It is important to note that credit cards are often provided to consumers with a 0% interest rate (APR) to start out, maybe for the first year. Then, the interest rate that is maintained on the card is very, very high when compared to other debt. Essentially, you are using the credit card as an I.O.U. on money that you “do not have”, and the credit card company is charging you for borrowing or using their credit.
Because there is no collateral backing the personal credit card use, the credit card companies are able to charge such high interest rates. That is the difference between credit cards or personal credit and that of auto loans and mortgages. With auto loans and mortgages, there is collateral in the car and your home. If you do not pay your auto loan payment or your monthly mortgage, there is collateral to be taken in those two assets. With credit cards, again, there is no collateral to be taken if you default on payments. However, the motivation to not tarnish your credit score, should be enough to nudge you against falling into that trap.
The goal with utilizing a credit card should be to pay your balance in full from month-to-month. By doing this, you are avoiding even being charged the high interest rate that credit card companies profit from. According to Wallethub, the average credit card interest rate is 17.87% APR (annual percentage rate).
What this means is that if you maintain a balance of $2,000 (for example) on your credit card, you will be assessed interest based on that 17.87% APR. Note that the interest being charged is not as simple as 19.21% multiplied by $2,000 (your remaining balance). The APR is divided by 360 or 365 (depending on the credit card terms), which gives you the DPR (daily percentage rate). The DPR is the amount that is applied daily to your unpaid credit card balance, and it compounds over time if the balance remains unpaid.
If the first goal of utilizing your credit card is to avoid the interest charges, the second goal is to take advantage of the bonuses and rewards programs that some credit cards offer. It is important to not simply sign up for credit cards just to obtain bonuses and rewards, and this is especially true if you have not mastered the first goal mentioned above. However, if you have a strong handle of managing your credit cards and paying your balance off in full each month-to-month, it is now time for you to flip the script and take advantage of the credit card companies.
Finally, to add additional nuance to better understanding credit card debt, it is still okay if your risk threshold or tolerance puts you in the camp of not using credit cards at all. For those that want a simple approach and would rather not worry about potentially accruing interest charges, fees, etc., going the route of not utilizing credit cards is 100% fine in our books.
Tackling Debt – Auto Loans
Most people need a car to handle their day-to-day lives, and we all have the choice to lease or finance the new (or used) car. In a future article, we will surely discuss the pros/cons of leasing vs. buying a car. However, in this article, we are focusing on financing the purchase of a car.
When financing to purchase a car, you are typically putting a dollar amount of money “down” towards the total car price, and then taking out a loan on the difference. Once you have the loan, you will pay monthly payments until the car is paid off. Depending on your credit score and several other factors, the interest rate could range from 0% all the way up to 16%. As a reference and according to ValuePenguin, the national average for U.S. auto loan interest rates on a 60-month (5-years) loan is 5.27%.
The most important things to think through when evaluating an auto loan is the interest rate, the use-case for the car, and your personal financial situation.
First and foremost, because a car is a depreciating asset, you really want to compress the interest rate and ensure that you are not paying too much money to finance the car. If you have good-to-great credit, most dealerships these days are financing cars with 0% interest rates. If you fit into that camp, this is the first green-light from our point-of-view.
Second, if you are going to put yourself into debt (big or small) for this car, then you want to make sure you have a strong and practical use-case for needing it. For instance, if you just moved from New York, NY to Newport Beach, CA, there could be a strong case to be made for needing a car. Public transportation in New York City is much more available than in other cities. It simply just may be the case that everything is so spread out in Newport Beach, that having a car is now a necessity.
Finally, you also really want to think about your own personal financial situation. As an example, if you have great credit (can obtain a 0% interest rate auto loan) and need a car to get you from home to work (without breaking down), but also have a goal to completely pay off your student loan, you may want to think twice about financing a Tesla Model X. Just because you can, doesn’t mean that you should.
When thinking about your own personal financial situation, you want to be realistic about the total dollar amount of the car and what that translates into in terms of a monthly payment.
Overall, when you do purchase a car and maintain the auto loan, there shouldn’t be a rush to pay it off unless the interest rate is very high. In most cases where the auto loan interest is going to be low, we would recommend paying the monthly payment per the term (usually 3, 5, or 6 years). In this fashion, you are able to manage tackling debt in a way that is more practical and has a long-term view in mind.
Tackling Debt – Student Loan Debt
For a lot of people, student loan debt is a very sore subject. Many graduates of colleges in the United States have gone into the workforce carrying massive amounts of student loans. In some cases, they took out student loans at a private college and ended up in a profession that had nothing to do with their major. While this can be crippling, we have also heard stories of graduates finding ways to pay off their student loans over time and once they do that, it is a great feeling.
According to Credible, the average federal student loan interest rates for undergraduates from 2006 through 2021 was 4.66%. For graduate students, it was 6.22% throughout this same time period.
If you value education and your future career potential hinges on undergraduate or graduate studies, then student loan debt is not a terrible thing. However, with the changing landscape of education, technology, and the workforce, the value of a traditional college education is being called into question. Therefore, the question becomes – is it worth it to get into student loan debt if college does not have the same payoff as it did 20 years ago. That is a tough question to answer and every single person is going to have a different perspective.
Either way, if you or someone that you know has student loan debt, having a game plan to pay it off is very important. Depending on your profession, we would highly recommend looking into any student loan forgiveness programs that you could qualify for. In addition, depending on your income make-up, there are several different student loan repayment plans that you can toggle from. To learn more about these options, Nerdwallet does a great job breaking all of this down. Finally, if you really want to get technical and crunch some numbers, it may make sense for you and your spouse to file your taxes as “Married Filing Separately” to optimize paying off your student loans. The College Investor does a pretty solid job explaining the nuances to this approach (if it makes sense).
We would also like to point out that student loan debt would (in most cases) fall into the category of “good debt”. However, because most students are not counseled enough prior to making the decision to take this on, we would highly advise on weighing out all of the different options. As parents, it can be very hard to tell your child no, we cannot afford this school. On the flip side, for an 18-year old, it can be very hard to think 4-5 years down the line in the future and what a $40K – $120K student loan is going to mean for them once they graduate. Nobody knows the future, but these kinds of decisions must be made with all resources at your disposal and thinking in the best interest of a child’s future.
Finally, there are a few high-level discussion points that we would like to highlight as it relates to student loan debt:
- There is a tax deduction that you can receive by maintaining student loan debt
- Recent tax law changes have made it possible to pay off some student loan debt from a 529 College Savings Plan
Tackling Debt – Home Mortgages
If you are lucky enough to own a home, having a mortgage is typically considered the “best debt” to have. Because home values (in most cities) rise in the long-run, we think that financing your home is a great use of capital.
Every person is going to be different and even though mortgages are considered “good debt” to have, we have certainly heard of people achieving goals of paying off their mortgage faster than the typical 30-year fixed mortgage. It is true that it would feel great to own a piece of property free-and-clear. While the financial answer may be to maintain the mortgage (especially with a low interest rate) and pay it off over time, the emotional (or psychological) answer may be to pay off the mortgage as fast as you can. Frankly, there is no wrong answer!
When financing your home, there are many ways to go about it and several options in regards to loan terms and mortgage types. The most common type is the 30-year fixed mortgage, but there are other options such as interest-only, adjustable-rate mortgages, 15-year fixed, 20-year fixed, etc. If you want to dive deeper into the different mortgage terms, take a read here.
One important note about tackling your mortgage debt is that there is a major benefit in refinancing your mortgage when the terms and timing are in alignment. If interest rates have gone down, the cost of refinancing is manageable, and the break-even analysis makes sense, you can lower your monthly payment and decrease the total interest paid during the life of the loan. This is a big win and should be considered when the opportunity presents itself.
Tackling Debt – Other Personal Debt
In brief, there are many other types of personal/consumer debt. A simple example in this category would be a personal loan through an online bank like Marcus, Ally, or SoFi. From our perspective, this type of debt would be in the same category as credit cards in terms of how we think about it. Interest rates are going to be on the higher range because there is no collateral, which according to Bankrate, the interest rates range from 3% all the way up to 36%.
Again, the interest rate is going to be dependent on your credit score. However, if you have a personal loan with a high interest rate, we would recommend prioritizing paying that off first (along with credit card debt).
This type of debt (personal loan) is going to be thought of exactly as a credit card (see above). However, if you are smart with making payments so you do not accrue interest, this type of debt could be helpful if you have strong need for capital/funds. Our general thought is that most people do not need to go this route and if they do, it should be thought of within their overall financial plan, making sure to consider all alternative options.
In conclusion, we really want to hit home the following points about tackling debt:
- Not all debt is created equal
- Maintaining some debt is a good thing
- Always consider the tradeoffs and opportunity costs between saving/investing vs. paying off debt
- Pay off your credit card balance monthly, so that you pay $0 in interest
- Make sure that you have a plan and strong use-case for any debt that you carry
- Paying off debt earlier than the terms of the loan is not only a financial decision, but also an emotional/psychological decision.
Additional Reads & Resources
Prioritizing Debt: Deciding Which Debt To Pay Off First
How To Get Out Of Debt In 5 Simple Steps
How To Prioritize Your Debt Repayment
Save First, Then Pay Down Debt?
Does It Make Sense To Pay Off Your Mortgage Early?
The Simple Dollar Guide To Auto Loans
How To Pay Off Student Loans Fast
What Is A Personal Line Of Credit?
11 Personal Finance Tips For Personal Trainers That Are Self-Employed
For more resources, you can always visit our “Resources” page.