Your Money: Managing Your Debt

By
Millicent Wong
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Your Money: Managing Your Debt

It's time to get your money in order.

Many of us make one of the most consequential financial decisions of our lives before we even reach legal drinking age: borrowing money for college.

Following the college acceptance letter is the financial aid package (“Aid,” lol), which is really just a nicer way of stating how much debt you will need to accumulate to pay for your education.

At this moment, Americans—teenagers!—are having their first encounter with the debt culture that is deeply ingrained in the way we pay for pretty much everything. The money is always there, ready to be taken to buy cars, houses, Lululemon leggings, and more. U.S. households carry more than $17 trillion in debt, for everything, credit cards included.

So while we have normalized debt in this country, we have also moralized it: If you have debt that you can't afford to repay, you must have done something very wrong.

But we know that's often far from true. Many people get into debt not because of lattes, nice sweaters and exotic vacations, but because of circumstances beyond their control, from health problems to job loss.

Then there are structural reasons why most people borrow, such as wages that don't keep up with the cost of education and a societal decision to shift more of the burden onto individuals. We should all be asking big, fundamental questions about how we ended up here — where college degrees often feel like luxury products and medical debt often leads to bankruptcies — and what it would take to change the status quo.

First, we'll focus on your microeconomics: how to improve your credit score, avoid debt when possible, and manage your debt so that you don't feel like you're being controlled by it.

The first part of debt management is simply becoming more aware of where your money is going and spending it wisely, just like Ron discussed in the third bootcamp session.

In an increasingly cashless society, we lose track of our spending more easily because there is little friction – you don't even have to pull a piece of plastic out of your wallet, you can just tap your phone and some money will be deducted from your credit card or debited from your bank account.

Buy-now, pay-later apps can be similarly insidious, allowing you to pay for virtually anything with an interest-free installment loan that's instantly signed somewhere deep inside your mobile phone.

Think of debt as a tool to be used wisely. It can also help improve your credit profile – and may already have done so.

In fact, people with debt who pay off their debts on time may already have a solid credit score. This three-digit number is used by lenders to evaluate you and decide whether to give you a loan (and how much interest to charge on it). Landlords often use this score when reviewing rental applications.

But too much debt can drag down your score, which typically ranges from 300 to 850—the higher the better. (With FICO, a score of over 740 is considered “very good.”)

Bottom line: Regular debt repayments help strengthen solid scores and improve less-than-perfect scores, which can lead to better interest rates down the road. (For more information on how to determine your ratings, see the Action Items section below).

There are several approaches to dealing with credit card debt:

  • Don't forget one of the oldest tricks: the good old balance transfer offer, where you transfer your debt to a credit card with a zero percent introductory interest rate. With interest rates rising, these deals are harder to find, but they're worth a try. Be sure to evaluate the transfer fees (which have increased) and how much you would have to pay each month to be debt-free after the introductory interest rate expires.

  • Another option is to consolidate your debts into a personal loan. Interest rates are almost as high as credit cards, but there are certain differences between individual lenders, so it's worth shopping around. You may be lucky, especially if you have good credit.

  • For people who have debt on multiple credit cards, the most practical method is called the avalanche method – you focus on paying off your most expensive debt first. Pay the minimum monthly payments on all your card debt (to avoid late fees). Then put the leftover money toward the credit card balance with the highest interest rate. Once that's paid off, put the leftover money toward the next most expensive debt.

  • The second strategy, known as the snowball method, may be more psychologically rewarding for people who want to get to their goal faster. Again, you pay the minimum monthly payments on all your debts, but you use the extra money first on the debt with the smallest balance. The logic behind this? You pay off your debt faster, which can be very motivating and encourage you to keep going.

  • Some people like to combine the two – first the snowball effect for a quick win, then the avalanche follows.

If at any point you feel stuck, there are professionals who can help you. They may even be able to negotiate a repayment plan with your credit card companies (but beware of scammers who make promises that sound too good to be true). Your safest bet is to find a nonprofit credit counseling agency through the National Foundation for Credit Counseling.

Medical debt is a little different than other consumer debt. After you've made sure the bill is correct and your insurance (if you have one) has paid every penny it should, ask your doctor to reduce the bill to a more manageable amount and then work out a payment plan. Even if you are being pursued by debt collectors, you should not put the debt on your credit card. Here's why: Once you do that, it will look like any other consumer debt.

Why is this important? The major credit bureaus have started to look at medical debt a little less punitively. (Read an article by my colleague Ann Carrns for more information.)

If you've already racked up credit card debt but also have student loans, you're probably wondering how to balance both. Even though federal student loan interest rates have increased, they're still far lower than most credit cards, which now have insanely high interest rates averaging 22 percent. The same rules apply here: You want to stay current on your student loans while also attacking your highest-interest debt first.

If you're overburdened with other consumer debt, there may be a way to safely reduce your student loan payment while you focus on the former. Plug your numbers into Studentaid.gov's loan simulator, which calculates your monthly payments under various repayment plans, as well as the amount of interest you'll pay over the life of the loan.

But this is a step that all students taking out a loan should take to ensure they have the best repayment plan given their circumstances.

For people struggling to make ends meet, income-driven repayment (IDR) plans may be the most affordable option: your monthly payment is based on your disposable income and the size of your household. After you make payments for a set period of time between 10 and 20 years, the remaining debt is forgiven.

The Biden administration's new IDR plan, called SAVE, is the most generous version (which is why it's being challenged by more than a dozen Republican-led states). Anyone who works in public service or at a nonprofit should also consider the Public Service Loan Forgiveness program, which can provide an even faster path to paying off your federal student debt.

If you're also getting private student loans through commercial lenders, there are a few things you should keep in mind. Federal student loans have built-in protections that private loans do not. With IDR programs, you may not have to pay anything at all if your income stops or you earn minimum wage, for example, and tools like Forbearance allow you to temporarily use the “Pause” button on payments. If you ever think about refinancing your federal student debt with a commercial lender, give it all up.

That's a lot to take in. If you need help, experts at organizations like TISLA can help.

The journey through your 20s is a time of self-discovery, including your financial personality. You may make suboptimal decisions that you won't necessarily regret, but those decisions will teach you. As long as the lesson isn't lost, you've gained something.

  • Your family background has likely influenced your attitude toward debt. Has your family been saving for big purchases? Constantly taking out loans for financial emergencies? Or were they financially comfortable but still managed to overextend themselves? Think about how your past life experiences may have shaped the way you deal with debt as an adult.

  • Make a list of all your debts, along with the interest rate you pay on them. Can you optimize somehow?

  • Everyone has a credit file with each of the three major credit bureaus (Equifax, Experian and TransUnion). Retrieve each of your reports (only through this website, where you get a free report from each office weekly) and scan them for errors. You can dispute any errors online.

  • Do you know your credit score? There are several places to look.

  • You have no debt? Take another look at the terms and conditions of your credit card and the interest rate – can you do better?

Ask us here.