Money Basics Series: Debt Management
There are loads of financial gurus who I won’t name that shame anyone who holds debt. I have shared some of my personal struggles with debt, and will undoubtedly share some more. But for this post, I wanted to share some information on key facts surrounding debt and some strategies to manage debt in your finances.
Your interest rate on any debt is what the lender charges you to borrow from them- whether this is credit cards, a mortgage, or student loans. A portion of each payment you make will be applied to the interest that’s accumulated since you made your last payment. In general, credit cards have very high-interest rates and mortgages have low rates. This is due to the additional risk involved in unsecured debt (see below). If you have several types of debt, then it may be best to prioritize paying down the one with the highest interest rate first.
Secured v. unsecured debt along with your credit score are the biggest determinants of how much interest you’re charged on a given debt. Secured debt is considered safer for lenders because it is tied to an asset, like a car or a house, that can be seized should you fail to pay. Unsecured debt includes things like personal loans or credit card balances. Since American Express isn’t going to come to your house and repossess those shoes you bought two years ago should you stop paying, it’s pretty risky for them to lend to you. That’s why they charge you so much more for a credit card!
“Good debt” includes things like your mortgage or student loans. Basically, it’s anything that is tied to an appreciating asset(your home) or facilitates you earning more money via increased knowledge. It is also considered good because these types of debt are often tax-deductible.
Side note: I don’t really like the terminology good v. bad but you’ll hear that a lot out there as you do further financial research.
“Bad debt” is usually unsecured debt and includes things like credit cards, personal loans, auto loans, etc. These types of debt usually have very high-interest rates, making them very difficult to pay off.
I think it is crucial to automate additional principal payments when we look at successful debt reduction plans. It’s very easy for your commitment to debt reduction to vary month to month because life happens. You get an unexpected birthday party invites, or your water heater goes on you. By setting the extra payments up automatically and not deciding how much additional you can pay every month, you set yourself up to actually achieve your debt payoff goal. I’ve seen it time and time again in terms of my own finances and my clients, and really feel like it’s the key to success.
I hope this was helpful. I know debt can be overwhelming or stressful, and I want to help provide thorough & simple knowledge from a trusted resource.
Resources should you need additional help:
Want some help developing a plan to pay off your debt? Reach out and let’s see if I can help.