We are known as an immediate gratification society and have a sense of urgency when it comes to things that we need or want, especially the wants! Sometimes, or perhaps, most of the time, these spending impulses lead us to swipe our credit card too frequently and before we know it, we’ve accumulated debts. There’s nothing wrong with spending money on something that makes us happy, but the most important thing to reach financial balance is to separate needs vs. wants. Categorize your wants and needs, then prioritize them. For now, we’ll leave the budgeting tips to that. The focus for this blog is to address debt that you’ve already accumulated and how to work on reducing it.
First thing, let’s address the common types of debt that people accrue. There is of course “bad” debt, but believe it or not, there is also “good” debt. You might be saying “But it’s money I have to pay back, with interest. How is it good debt?”. Let me explain. As bad as debt might sound, and it is, sometimes we can get some benefits from it. An example of good debt is student loan debt. The good of it, you ask? You can deduct the interest amount you pay on them from your taxes, up to a certain limit per year. Also, the interest rates on student loans are typically low. You can receive the same benefit with debt associated to your mortgage or business. Another reason these types are considered “good” is because the money we invest in school, our homes or a business are being used to create a better quality of life and have some form of return that isn’t simply cosmetic. Student debt comes as a result of acquiring a college education that you hope will lead to well-paying employment; a mortgage comes as a result of buying a home that will house a family for years to come and possibly be passed down; a loan for a new business results from pitching an idea you hope will allow you to make a living or additional income.
As for bad debt, you can probably deduce what this is from what was discussed for good debt. Bad debt is pretty much any type of debt that you don’t get any benefit from and has a high interest rate. These debts are personal loans and debt accumulated from credit card purchases. Now that we know the types of debt, let’s tackle how to prioritize debt reduction.
The first thing that comes to mind when we are looking to pay off debt is usually that we need to make more money so that we will be able to pay it faster. While, yes, more money would assist you with this process, it’s not realistic that your income will change soon enough to help with this process. Also, it’s probable that with more income, you’ll be tempted to raise your standard of living to match. If you’re not disciplined, you’ll fall into the habit of “Oh, I can buy this brand now!” even though the store brand might have been just as fine a week ago. Behavior like this will just have you breaking even, instead of strategically using additional funds to pay off debts and save in a timely fashion. The most important thing that you can control right now when it comes to debt reduction is creating a good budget. There are plenty of stories of people who paid off thousands of dollars in debt from reducing expenses and following a strict budget for months to years. You have to ask yourself how much being debt free means to you and put in the work because it’s most definitely possible.
Sit down and start with what you bring home in a month and begin to subtract your fixed monthly expenses (rent/mortgage, car payment, insurance, telephone, etc.), your estimate of how much you spend on entertainment, and the amount you set aside for savings/debt reduction. When you’ve done that, see what you’re left with. If the end number startles you, look at the itemized list of your entertainment and fixed expenses and think about what you could reduce or simply do without.
After establishing a solid budget, the next thing is to set up a plan for what debt to tackle first. The best option for this is to pay attention to the debt with the highest interest; this will usually be credit cards. Work on paying these off first because they will cost you the most the longer they are in repayment mode. Here is an example for clarification: If we have a student loan debt with 5% interest, a car loan with 3% and credit card with 20% interest, the best thing to do is to try to get rid of the highest interest rate debt first while making minimum payments to the other debts.
So, to wrap up, there is nothing wrong with having debt as it might be needed in certain situations and moments of our lives. Understand the type of debt you have and assess where your money should go towards first for repayment. Debt is a burden, but it can be slayed with the right financial know-how, a good amount of discipline and a plan. If you’d like to talk to our advisors about how long it might take for you to pay off your debts or to help you find extra money per month by analyzing your current spending, schedule an appointment with us using our online portal. We’re here to help!