DEBT

What it is.

No surprise here: debt is something you owe. The longer you take to repay that debt, the more it costs you. Time is money, right?

Where it comes from.

If we’re just looking at debt as money, then your debt comes from someone who has extra money. Those people with extra money don’t need to spend it and don’t want to spend it, but they also don’t want it just out there sitting pretty. They’d rather their extra money turn into more money. Smart, right? So they lend it to someone who doesn’t have enough money to buy what they want—let’s say you. And they put a price on this money and a price on the time it takes for them to see this money. You know what it’s called when someone’s vested in something. Interest.

The amount you have to fork over in interest each month depends on a handful of things. How much are you looking to borrow? How long are you going to take to pay it back? How often are you planning on making payments? Did you put some money down upfront? Is there some collateral? What happens if you stop paying? Why should you be trusted in the first place? Have you had to pay anyone back before? Well…so did you pay them back?

All of these questions boil down to this: This debt…are you good for it?

That’s where you credit history comes into play. Your credit report shows just how risky you really are. It’s one of those times in life you actually want to be boring.

Revolving vs. Installment.

Credit cards, loans, mortgages… You can rack up debt in different ways and for different things.

Credit cards are a form of revolving debt. There’s a limit on how much you can spend, but your balance may vary from month to month. So unless you’re a champ and pay off your balance in full each month, your required monthly payment will go up or down depending on how much you still owe. Be a champ.

Installment debt is usually your student loans or your mortgage. You have a set amount you pay at a set rate. You’re just paying your balance down to zero.

Why have it.

All debt isn’t all bad. Some debts are even good.

My student loan debt, for example, is an investment I made in my future earning potential. The interest rates aren’t outrageous, and I have a generous amount of time to pay them back. You don’t get to haggle with the government over what rate you’ll pay on these loans. They’re set by Congress. But you can know ahead of time what you should expect to pay and plan accordingly.

CURRENT AND HISTORICAL INTEREST RATES FOR STUDENT LOANS – Federal Government

Without my car loan, well, I’d be in a pickle. When an 18-wheeler totaled my 13 year old Ford, the driver didn’t check with me first to see if I’d saved up enough to buy a new one. (By that, I mean a used one.) I used my insurance check for a down payment and took out a loan for the rest, paying around 4% in interest.

Is 4% a good interest rate? For a car loan right now, yeah. Before you head into a dealership, though, it’s a good idea to go online and look at current rates. This way you’ll know what you should expect to agree to in your loan contract.

CURRENT AUTO LOAN INTEREST RATES - Bankrate

And a house? Well, I don’t have one of those. Don’t worry, I come home to a very rotund feline every night. It’s just not a place I own. [Neither does the cat.] Mortgages allow homebuyers another way to invest in their future selves. We spend a large chunk of our income on housing. With a mortgage you’re spending that money on a place you’ll own rather than a place someone else owns. And right now, mortgage rates are at an historic low.

I can’t wait for future history books to title this time period: Not a lot of Interest in the World.

CURRENT MORTGAGE INTEREST RATES - Bankrate

Credit cards are usually an expensive debt to hold because banks charge a pretty high interest rate, and you don’t have a lot of control over the rate you’re paying. If you’re paying off your card every month, though, you’re probably reaping more benefit than boon. Credit cards typically provide greater protection from identity theft than a debit card. It’s easy to dispute a charge, the credit card company will oftentimes launch their own investigation into cases of fraud, and you are likely to be reimbursed for any fraudulent charges. When banking information is stolen from your debit card (or your check…), the stakes are higher. A thief has immediate access to your cash balance. Depending on your bank, you may or may not be reimbursed. And there is usually a smaller time frame for you to report the theft to your bank in order to qualify for repayment. When you spend money with your debit card, you’re spending YOUR money. When you spend money with your credit card, you’re spending the credit card company’s money.

It doesn’t take a genius to commit identity theft. All you need is a skimmer at a gas station pump. So, a credit card may be a layer of protection you rely on. My car is one of those that needs gasoline. Before my sister’s wedding in January, I fueled up at an unfamiliar station and headed to the chapel. In the morning I received a text from Chase asking me to verify a charge. After I denied the charge, Chase called me. My information had been stolen. The thief had then created a phony card with my info. And now they were out West trying to buy McDonald’s (more than once). After a five minute phone call, I knew to expect a new card, and I didn’t have to worry about that phony buying a burger and fries on my dime. Good lookin’ out, Chase.

How to pay it.

Make it a habit to pay your credit card balance each month in full. Just because you CAN spend up to your limit, this doesn’t mean you SHOULD. Say you have three cards with a spending limit of $10k. If you only make $3,000 a month but max your cards out on a shopping spree, you’ll be paying pretty dearly for that debt.

Make your regular payments on time. It isn’t worth it to be late, and it dings your credit history.

Prioritize paying down high interest rate debt. I do this with my extra student loan payments. I don’t put the extra payments towards the loans at 3%. I pay extra on the loans over 6%. They’re more expensive. I pay extra out of my checking account, though. I DO NOT pay my student loans – even a student loan with a rate above 6% – with my credit card. Bankrate.com shows current variable interest rates on credit cards at 16.31%. I’d just be taking on more debt if I paid off a 6% interest rate with a 16% rate. There’d be no point.

CURRENT CREDIT CARD INTEREST RATES - Bankrate

Free apps for it.

Apps like Mint and LearnVest help you to keep track of when payments are due. They’ll also categorize your expenses and let you know how much you’re paying in interest on a credit card each month. It’s a pretty good motivator to pay your balance off in full each month. Wouldn’t you rather spend that money on yourself instead of paying the bank?

Ez Calculators is pretty neat. It has a number of loan calculators that’ll help you figure out payments and interest rates. It has a credit card minimum payment calculator that’s just a REAL fun way to see how many years it’ll take you to pay off the balance on a card if you only make the minimum monthly payments.

Walla.by is my favorite. It simplifies credit card points. Instead of having to figure out which card to use at a store to get the most points, you just open the app, and it tells you. If you forget to use it and pick the wrong card, it’ll let you know just how many points you missed out on. Won’t make that mistake again.

The Debt Hangover - Midday Money on WLBT

This afternoon, Nancy was on WLBT's Midday segment, and she discussed debt.  Watch the video here:  The Debt Hangover!

paying off debt

Last week I paid off the last of my student loans. I did not have a lot to start with, so finally getting rid of them after only 4 years was not a difficult task.

Paying off debt can be a huge emotional relief. It seems like it would be a financially savvy move too - but that is not always the case. Let's look at when it makes sense, and when it does not. The general rule of thumb is that you should pay off debt when the interest rate is as high as, or higher than what you could earn on that money elsewhere. For a point of reference, I generally look at long term investments earning 6% or more (over 10-20 year periods).

Mortgages are the biggest debts Americans owe. These are very long term debts and money is cheap right now! With my mortgage at 3.5% I am in no hurry to pay that off, as I expect my long term investments to earn a premium over that. However, even at these low rates, there are special cases. There are various thresholds which may benefit the homeowner to be under:

• Paying a little extra off before you refinance may help put you under a threshold to get a better rate. Namely, prime rate mortgages generally require 20% equity or more, so if you owe $121,000 on a $150,000 home, paying an extra $1,000 might translate into big savings on interest. 
• Certain loans may have Mortgage Insurance Payments which go away once you hit a certain threshold. For instance, FHA loans typically require 22% equity before the mortgage insurance payment goes away. The insurance payment will vary with the program, so check with your mortgage servicer to see where your threshold is.
• Refinancing. If interest rates are lower than when you got your mortgage, look into refinancing. Though the monthly payment may be higher, a shorter term loan may have a lower interest rate, and the faster amortization will mean you pay less interest overall.

Credit Card debt is a big problem. While this is some of the most flexible debt you can obtain, you pay dearly for that flexibility.

• Check your interest rate. Rates on credit cards are typically variable and if you carry a balance, will probably only rise. Average APR right now is over 15%, though cards with rates from 20-30% are not uncommon. With an interest rate of 18%, every $66 you owe translates to about a dollar of interest a month - that's money you never benefited from.
• Many cards come with an introductory 0% APR. If you need to, take advantage of this, but you will want to pay down the balance aggressively before the interest rate shows up.
• Lower your total credit utilization. This is a question of thresholds again. Your utilization ratio is your total balance outstanding to your total credit available. This total is from all of the cards in your name - 50% would mean that the sum of all of your balances is half of the sum of all of your credit limits. The recommendation is to keep the ratio under 30%, but the lower you go, the better. This accounts for almost a third of your FICO credit score, so it may be worthwhile to pay down even a low or 0% interest card if you need your credit score to drift up.

Student loans are in the headlines in very scary ways lately. Rising use of student loans has been in a vicious cycle of being needed to pay ever higher tuition while also making it easier to bid up the cost of said tuition. In general, student loans are a great idea - it is some of the easiest debt you can get, and you expect to earn enough to comfortably pay for it when you graduate. The problem now is that people are not getting payed quite what they expected. Government program loans are typically fixed rate and for a 10 year term while private loans are have variable rate options and different terms. The lowest rates are for undergraduate loans, but graduate and parent loans are a much higher rate that may usefully be paid off early. There are repayment programs available to help ease the cost of the loans when you first start paying them back.

Debt can be intimidating, but that doesn't mean it can't be useful as well. The decision to pay off debt is just as important to consider carefully as the decision to take the debt on in the first place.