High interest debt is draining your wealth. It doesn’t need to be that way forever, though.
Jackie Beck over at The Debt Myth is encouraging a movement around the idea that debt doesn’t have to be forever. I’m joining in with a few thoughts on my approach to debt, even though my view of debt probably isn’t keeping entirely in line with the idea of becoming completely debt free.
My Focus: High Interest Debt
My main focus has long been on high interest debt. When you have a lot of high interest debt, it saps your wealth. One of the reasons that credit card debt can be so difficult to shake has to do with the fact that compound interest means that you keep paying interest on your interest. Not only that, but some high interest, especially credit card interest, is compounded daily. That means that every day you have high interest credit card debt, your balance continues to grow.
If you’ve ever made payments on your credit card, you know that your balance goes down very slowly when you have a credit card and only pay the minimum payment. This is because most of your payment goes to interest. Unless you make it a point to pay more than the minimum, it is hard to pay down your high interest credit card debt — and it can be disheartening.
The good news, though, is that your high interest debt doesn’t need to be forever. You can start making inroads in your debt if you create a plan to tackle your high interest debt. One of the things you can do is use your credit card statement to help you create a debt reduction plan. Your statement should show you how much you need to pay in order to pay off your card in three years (as compared to paying just the minimum). This can be a great starting point for your debt pay down plan, since you can get a rough idea of what to pay each month. Look for ways to cut spending or earn more in order to get the extra you need to pay down debt.
Realize, though, that you don’t need to be able to pay off everything all at once. Take into account your situation and your ability to pay. You might need patience as you work to pay down debt. The important thing is to make realistic goals, and then mark your progress. As you start paying down your debt, stay motivated, and remember that it doesn’t have to be forever. Your debt pay down plan can provide you with hope, and let you see progress. Get rid of that high interest debt, and then you can consider what’s next.
Why I’m Not Debt Free — And Don’t Care If I Am
Here’s where things go off the rails for me and paying down debt. It’s true that debt doesn’t have to be forever, and that you can be truly debt free as early as possible. And if that’s important to you, by all means, pay it off and get that peace of mind.
However, I don’t think all debt needs to be paid off early. I never made an effort to pay off my mortgage early, and I’m not making an effort now to pay off my student loans early. My federal student loan rate is less than 2 percent, and the interest paid is tax deductible. If I were to pay off my student loan early, my annualized return would be 1.7 percent at best after factoring in my tax deduction. I can invest that money (and I do) an see a 6 percent annualized return — and that’s a conservative estimate. Long-term, I just don’t see the benefit.
And, frankly, I don’t see much reason to pay off even my car loan early. At least, as long as I can get low, low interest rates. My last car purchase resulted in a low-rate loan. Rather than?tie up my capital in a car that depreciates, I’d rather get a loan, and then invest my money in something with a higher rate of return. Of course, as interest rates rise, this won’t be my strategy. But as long as I can get a rate of less than 3 percent, I see no reason to buy my cars with ready capital when that capital could be earning much more for me.
But that’s my take on it. In the end, you need to do what’s best for you, and what you are most comfortable with. If you are determined to be completely debt free, it’s possible for you to do so. With the right priorities, and a good plan, debt — especially high interest debt — doesn’t need to be forever.
I definitely think people should have a better grasp of what they really want out of their life and financial life. You’re right not all debt are the same. Any credit card debt or financing company debt is a no in my book. It’s just so easy to fall into the trap of what you mention the high interest dilemma.
It’s important to weigh the pros and cons. What is the debt actually doing for you, in terms of cost. Most of the time, that high interest debt really isn’t providing you with much, but it’s costing you a great deal. The benefit just isn’t there. Low-interest debt, on the other hand, can provide you with opportunities, especially if it comes with a tax deduction. But even so, you need to be careful.
The main reason we’re paying off our low-interest car loan as quickly as possible is because of cash flow. We can’t live on my primary income alone, and though my freelancing income has been great over the past year, there’s always that fear in the back of my mind that I’ll get dropped by my bigger clients. If that ever does happen, heaven forbid, hopefully we’ll have a little less pinch in the cash flow.
Cash flow is a BIG DEAL, so it’s good to plan for it. You’re right that you need to be comfortable with your situation, and cash flow is a major part of it. Whatever you decide to do about your finances, it needs to work for you. 🙂
True. A lot of us want to be debt-free for a variety of reasons, but mostly so that our money can be earmarked for other expenses or even in savings. I agree that we need to consider what the debt is doing for us. And definitely set realistic financial goals that we are comfortable with.