3. Pay Off High Interest Debt - Credit Cards & Personal Loans

High interest loans will erode your ability to save and invest. You'll never outperform a 25% interest rate charge by investing. Get rid of it.

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Reasons

 

Debt is the ultimate obstacle when it comes to saving money and investing

• Credit card debt is the easiest trap to fall into and typically carries the highest amount of interest. The amount of credit card debt that you don't pay off at the end of the month will accrue interest.

• This is very impactful because if you don't pay off your credit card debt, the interest charge will be added to your total balance and will negate some (or sometimes all) of your payments towards the principal.

• The more money you put towards paying off your credit card debt the less money you'll have to save and invest.

• Some people prioritize saving and investing over paying off credit card debt, but you will never "out-invest" your interest charges.

• Get rid of this debt and allocate those dollars to saving and investing.

 

Paying Off Personal Loans

• Personal loans are a bit different than credit cards as you typically receive a lump sum and pay back the loan over time.

• With this debt, you have a firm repayment plan (typically monthly) that has an end date.

• I'm actually a big proponent of using personal loans to consolidate credit card debt into one payment.

• The interest rates are typically lower, the repayment amounts are fixed (and hopefully more manageable), and most financial institutions allow you to pay these off in full if you can.

• However, this monthly payment will also hinder your ability to save and invest money, so do your best to pay this down as quickly as possible.

• Do not use personal loans for anything other than consolidating your debt. Taking out a loan to buy yourself something is not worth it. If you can't pay cash, don't use a loan.

 

Buy Now, Pay Later

• As if credit cards and personal loans weren't enough, financial institutions have created the "Buy Now, Pay Later" scheme.

• I'm sure you've seen it everywhere - it allows you to pay for these in fixed installments (monthly, quarterly, etc.) and typically interest free.

• This may seem like a good idea, but it can lead to the trap of (1) over-buying because the installment is "more manageable" and (2) large fees if you miss an installment payment.

• Again, if you can't pay cash, don't buy it. 

 

The Psychology of Debt

• Debt is scary and can lead to a negative mindset. It can make you feel like you're trapped and aren't progressing towards your financial goals.

• I know from experience - I've been in credit card debt 3 different times in my life.

• It's this snowball effect where the purchases start off small, you think you can manage it, the amount starts to grow, you don't want to use all of your cash to pay it off, and it spirals further.

• You then end up in this endless cycle of trying to pay down your debt with all of your cash, only to leave you cashless at some point of the month and pushing you back to use credit cards.

• I don't say this to scare you more, but just to let you know that I've been there and I've dug myself out each time.

• Take a deep breath, make a plan for yourself, and attack your debt with a vengeance. Don't let debt control your life.

 

Tips       

 

Credit Cards - Do it the old fashioned way with cash

• First, create a budget for yourself so you know what you take home and what you spend -> this will allow you to set a monthly target for yourself that is reasonable and attainable.

• For example, if you bring home $5,000 per month and you spend $4,500, then you physically cannot allocated $1,000 per month to paying off debt.

• However, the budget exercise can provide insight into what you're spending your money on and provide potential opportunities to decrease your spending on things you don't need.

• It is very important to ELIMINATE frivolous spending. You can enjoy your money once you get out of debt, but you need to focus on paying off your debt first.

• Method #1

  • In my own experience, I found it effective to save cash first before paying off credit card debt (I paid the minimums for this month). This is the reasoning behind Guideline #1.

  • Having extra cash on hand will decrease (or hopefully eliminate) the need to use credit cards, therefore allowing you to focus on using additional income on credit cards.

• Method #2

  • Dave Ramsey has a great tip known as the Snowball Method:

  • Start by listing all of your debts and put them in order by balance from smallest to largest—regardless of interest rate. 

  • Attack the smallest balance first and pay the minimums on everything else.

  • Once it's gone, take that payment and put it toward the second-smallest debt, making minimum payments on the rest.

• This will hopefully make paying off multiple credit cards feel more manageable.

 

Credit Cards - Use a Personal Loan

• I know it sounds contradicting to use debt to pay off debt, and this definitely not my first suggestion, but sometimes it is a necessary evil.

• If you have debt on multiple credit cards, it can be overwhelming to keep track of it all. Which ones did I pay? How much have I paid in total? Did I miss a payment? Etc.

• Consolidating credit cards into a personal loan will allow you to have to keep track of only one payment on a monthly basis.

• And since it is a loan, there will be a fixed interest rate and a fixed term, therefore you will have an end date in sight!

• Personal loan typically (with an emphasis on typically) have lower interests than credit cards, so you will pay less in interest over time.

• How it works:

  • A financial institution will provide you with a lump sum of money. You determine this amount by adding up all your credit card debt.

  • You will use this money to pay off each credit card.

  • Finally, you will pay off the loan as if it were a car payment or mortgage on a monthly basis.

  • TIP -> The more you are able to put towards principal (via additional payments) the faster you will pay off your loan and the less interest you will pay.

• DO NOT USE YOUR CREDIT CARDS ONCE THEY ARE PAID OFF.

• Let me say that again - DO NOT USE YOUR CREDIT CARDS ONCE THEY ARE PAID OFF.

• The absolute worst thing you can do is rebuild your credit card debt AND have a personal loan payment. And yes, I hope I scare you here.

• If you are uncomfortable using a personal loan, do not convince yourself to do it. Your gut feeling is probably right and you should refer to the cash method above.

 

Debt Elimination

• I don't know much about debt elimination, but it feels sketchy. Working with a provider to "eliminate" or "lower" debt without paying it down feels like there is some sort of catch.

• I also believe there are tax implications if you are successful, so please keep that in mind.

• I'll do more research on this to provide a better overview.

 

If you are having trouble with paying down debt (similar to #1):

• Find a purpose bigger than yourself

  • This one is purely psychological and may not be for everyone, but if all else fails, do it for someone else.

  • From my own personal experience, I am more motivated by my family then I am for myself - find a person (or people) in your life that motivates you to be better and do it for them.

• Get competitive

  • Find someone with similar goals and compete against them to try and save. 

  • I find that competitive people hate losing more than they like winning - use this to your advantage to pay off debt.

  • A competition will also create transparency and accountability - you'll have to physically show your competitors the amount you paid off, so there is no lying here.

• Get a financial coach

  • No, this is not an advertisement to use my services.

  • But having a financial coach to keep you accountable (much like a personal trainer) may help get you towards your goal faster.

  • An add-on bonus here is the motivation of seeing someone who has already accomplished your goals so it may push you to work harder towards this.

  • CAVEAT -> This tip is irrelevant if you have to pay someone a lot of money, so try to find someone willing to do it for free (I'd be happy to do it) or at an affordable rate that you feel comfortable with. And stay off social media, most of those "gurus" are clickbait monsters and aren't practical.

 

Why didn't I include car payments and student loans (like Dave Ramsey)?

• For one, these are big payments. Not everyone has the funds to simply pay off a car or their student loans.

• There is also an argument that this money can be used to saved and invest so it might make sense for the long term. This is because interest on car payments and student loans typically are lower than the rate of return of investments.

• This is not always the case as some loans are higher than others. An average return from the S&P 500 is roughly 8-10%, so if your interest rate is lower than that then you should invest it. If it's higher, than look to pay off your loans.

• Ultimately though, if you have the means and want to pay off these off, then feel free. I'm definitely not advocating against it, just giving my opinion on it.