Foundational Money Habits 3: Repaying Debt
There are a million ways to do anything, but my advice is always to start with small, manageable, and repeatable actions to build good habits. Having a good relationship with money has little to do with a high income and how much nice stuff you own and everything to do with living within your means and saving what you can.
Making big, sweeping changes all at once can set you up for disappointment when you inevitably hit a bump in the road. Instead, start small with actions you know you can manage and let those small victories build into something you can be proud of. Here are four easy to understand foundational habits that anyone can start using today:
Spend a little bit less than you want to.
Save a little bit more than you have been.
Pay off debt a little bit faster than you need to.
Invest what you can when you can for the rest of your life.
I consider those four topics – cash flow, saving, debt management, and long-term investing – to be foundational to good financial health. I start each client relationship with a review of those fundamentals to establish a baseline (where are you right now?) and identify easy to understand practices that can help build the habits that will take you where you're going. There are certainly other important topics in personal finance, but getting those four right will set you up for a lifetime of positive financial health.
So let's dive into the next topic and identify a few easy to understand ways to build good habits!
Pay off debt a little bit faster than you need to.
Most of us are taught variations of this lesson at a very young age: debt is bad, living with debt is stressful, and you should eliminate it whenever possible. Being debt-free is certainly an advantage, but debt is a financial tool that – like all others – has its upsides & downsides.
Debt can be a means to acquire a home (which can build long-term wealth) or pay for higher education (which can increase income potential). Those are both great things. But unsecured debt, like credit cards, can quickly become an unmanageable burden and even "good" debt – the kind used to pay for something that will improve your overall financial health – can get out of control if people start skipping payments.
Paying down debt is important, but it is only one part of financial health. Before you go all-in on eliminating debt from your life, it's important to consider the state of your emergency fund, retirement savings, and overall impact on monthly cash flow.
Here are three ways you can keep it easy while repaying debt:
Always pay at least your minimum payment – every lender wants to get their money back, so they create a payment schedule by which you can repay your entire loan.* Sure, they're happy to charge you interest along the way, but you will eventually eliminate the debt if you pay the minimum amount on time without adding additional debt. Once you start skipping payments, though, you'll be hit with both accumulating interest fees and late penalties. You can avoid those unnecessary costs simply by paying the minimum fees each month. Also, on-time payments can improve your credit score, giving you more reliable access to loans in the future, while late payments will erode your credit score and make it harder to access loans.
Not all debt is created equal: prioritize high-interest debt repayment – Loans that are backed by assets are called "secured loans". The lender takes on less risk for secured loans (since they can take the asset away from you if you stop paying) and so they typically offer more favorable terms like lower fixed interest rates for the duration of the repayment term. Unsecured debt like credit cards, on the other hand, is not associated with any assets (the lender can't repossess the groceries you bought with your credit card) and so the lender compensates for the higher risk by charging higher rates that fluctuate based on inflation. That means that not only will you pay significantly more in interest fees for credit card debt, but that interest rate can increase without warning. Again, always pay at least the minimum payment each month for every debt, but if you are in a position to pay more than the minimum amount it's a good idea to prioritize those loans with the highest interest rates.
Overpaying by even a small amount will help you in the long run – A common question is whether to use extra money to invest (which we'll look at next week) or pay off debt. This does not need to be a binary "all debt" or "all investment" question, though; how about a little of each? You can shave months or years and save hundreds, thousands, or even tens of thousands of dollars over the course of a loan by overpaying be as little as 10%. Consider this example: if you bought a house today for $250,000 with a 30-year, 7.4% APR (about the current national average) mortgage and overpaid by just 10% more than the minimum payment ($1,476 instead of $1,342), you would save almost $49,000 and pay off your mortgage five and a half years sooner. Not bad for an extra $134 per month!
I'd love to hear any of your helpful tips & tricks for managing debt – especially the mindset side. The next post will finish up our Foundational Money Habits review by looking at long-term investing.
Timothy Iseler, CFP®
Founder & Lead Advisor
Iseler Financial, LLC | Durham NC | (919) 666-7604
Iseler Financial helps creative professionals remove stress while taking control of their financial futures. As both advisor and accountability partner, we help identify current strengths and weaknesses, clarify and refine your long-term goals, and prioritize understandable, manageable, and repeatable actions to bring long-term financial well-being. Reach out today to take the first step.