For many investors in the accumulation period of their financial journey, debt has become a significant concern. From mortgages and student debt to credit cards and car loans, the opportunity to accumulate large amounts of consumer debt is seemingly endless.
At Bienvenue Wealth, we firmly believe that you can pay down debt without giving up the important aspects of your life.
So, how can you accomplish this rather lofty goal?
THE FIRST STEP? PRIORITIZE YOUR MONEY
Good news! If you’re reading this article, you have already started the process. Understanding that your debt level may be an issue and seeking knowledge to address the problem is critical. At this stage, you need to start with the basics.
- Understand Your Debt: Simply write down the details of your current liabilities. This would include the type of debt (i.e., mortgage, credit card, student loan, etc.), outstanding principal balance, interest rate, and payback period/frequency.
- List Out Your Income and Expenses: Next, make sure you understand where your money is coming from and going to. Start with income and fixed expenses. Then, do your best to estimate your variable spending habits. Gaining clarification on these numbers is empowering. You will highlight areas for improvement (i.e., make more money, reduce variable spending, etc.).
- Write Down Your Goals: What are you trying to accomplish? When do you want your debt to be paid off? How do you plan on doing it? Use the S.M.A.R.T Goal guide to ensure your strategy is specific, measurable, achievable, realistic, and timely.
Minor details and percentages during your accumulation years can have a compounding effect on your finances. Getting granular with your strategy early on can reveal significant opportunities.
THEN, STRATEGICALLY PAY OFF YOUR DEBT
Once you understand your debt, have a grasp on your income and expenses, and have established S.M.A.R.T goals, it’s time to get strategic about paying down your debt.
- Pay Off High-Interest Rate Debt: Assuming you have “X” amount of dollars every month to pay down your debt, you’ll want to optimize your strategy. From a financial standpoint, some types of debt are better than others. Financing long-term projects and paying as you go, while taking advantage of a low interest rate environment is a good use of debt for purchases like a home mortgage or automobile. When you carry a $10,000 balance on a credit card for plastic goods you bought last year, that is bad debt that should be eliminated immediately. Any time you are borrowing money to subsidize your cash flow needs, a warning bell needs to go off in your head. You may be living above your means and need to make adjustments. This is where GenX gets in trouble. Borrowing at 19% while your savings account pays .01% is detrimental to your family’s financial future.
- Pay More Than The Minimum: Banks and lending institutions want you to pay the minimum payment every month. Doing so gives them the ability to make more in interest payments over the life of the loan. Think about it like this: just because your car loan has a 5 year payback period doesn’t mean you can’t pay it back in 3 years.
- Explore Refinancing: If your interest rates are really out of control, you may want to explore a refinance. Refinancing is simply the strategy of using a new loan to pay off your existing loan to lower your interest rate. For example, it is not uncommon for private student loans to have interest rates above 8%. Depending on the current market conditions, you may be able to refinance down to 3% at little to no upfront cost.
ALONG THE WAY, KEEP BUILDING YOUR RETIREMENT FUNDS
Your finance mixtape doesn’t have to just be about paying debt and nothing else. You want (and need) some variety.
Paying off debt doesn’t mean you stop saving for retirement. When in your peak earning years, your debt and retirement savings become equally critical.
WHY YOU SHOULD INVEST AND PAY DOWN DEBT
- Tax Savings: Neglecting retirement accounts can hurt you from a tax standpoint. For example, let’s assume your marginal federal tax rate is 24%, and you are currently maxing out your company 401k plan ($19,500 in 2020). If you decide to stop contributing to this account to pay down debt solely, you will increase your federal income tax by $4,680 (all else equal). It may still be the best strategy, but it’s certainly worth considering.
- Opportunity Cost: When trying to balance investing and paying off debt, the concept of opportunity cost is significant. Put simply, what are you forgoing in investment growth to pay down your debt. We see people prepay their mortgage debt while carrying a credit card balance. Again, consider good debt vs bad debt.
- Momentum and Balance: Believe it or not, investing and paying down debt is done by humans (not robots). Sometimes, we need to see a little balance in our strategy to maintain momentum. If you use every last dollar to pay down your debt, it may be hard to maintain optimism. Investing is often associated with more positive emotions while paying down debt might feel like you’re trying to address an issue or solve a problem. Don’t let one goal overtake your other goals, work to address each of your goals routinely.
The world of personal finance is dynamic. You have to manage competing priorities constantly. At the end of the day, you’re always working towards the same goal of maximizing your resources to live a fulfilling life that is true to your current and future values.
FIND A TRUSTED FINANCIAL PARTNER
On the surface, paying down debt can seem like an insurmountable task. At Bienvenue Wealth, we believe that if you prioritize your money, strategically pay down debt, and balance your investing and debt strategy; you are capable of tackling this pesky issue.