Loaded Questions: What’s the best way to pay off my debt?
It’s been a busy month. I had a few people ask me this month for a debt payment plan. Their questions were disguised as other topics. For example, one couple wanted to know if they should use savings or retirement accounts to pay off debt. Another person wanted to know if they should pay more on their student loan right now. A couple of people wanted to use this downtime of 2020 to pay off credit cards. My answer to their questions had roughly the same structure, and I want to share that with you today. We are talking about unsecured debt. That means debt that from credit cards, personal loans, student loans and the like. If you’ve already paid these off, then you can add in your car payments and mortgage to the mix. But for now, let’s leave those out.
Hi, I’m Christina Gamache, founder of Audax Wealth Management. I’m not your typical financial advisor. I don’t earn a commission on any products that I recommend because I don’t believe in having a conflict of interest. I work with business owners, women and families who need good, solid financial advice. I help them organize their financial priorities so they can take care of the things that matter the most to them. As a financial planner and a fiduciary, I have three thoughts that you may want to consider if you are one of these people asking this loaded question.
Why do we need to pay off debt? Debt is defined as something that is owed to another person or entity. It’s my experience that most people don’t like owing something to someone else, whether that’s a favor or money or anything else. There are some cases where debt can be a good thing, but that’s usually if it is being leveraged as a business strategy, for example. Regardless, if someone is in debt, that means they are bound to the terms they originally agreed to in order to get an extension of credit or favor. In turn, someone who is in debt cannot truly be free of these terms until the debt is repaid. If you have debt, you then owe a piece of your income each month to someone else until it’s repaid. Think of all the missed opportunities you may have because you are giving this extra payment to someone else instead of investing it or using it somewhere fun. You need to pay off debt so that you can be free to make your own decisions on what to do with your income.
First, I do not recommend using retirement accounts to pay off debt, even though the IRS is currently not penalizing early withdrawals due to COVID. If you are in dire need of course and you have no other options, then maybe it does make sense to you. Why? Well, you have likely saved for retirement over a period of years. This means that you are taking advantage of the power of compounding and earning interest upon interest, growing your retirement accounts until you need to access them because you are no longer working. When you withdraw or “borrow” from your retirement accounts before you are at least 59 ½ years old, you are hurting yourself in the long run.
Instead, figure out your monthly budget. Where can you squeeze more money out of your budget for extra debt payments? Right now we aren’t going out to eat as much, we aren’t taking vacations, we’re sitting at home. How can you reconfigure your budget to start paying off debt?
Second, get out a piece of paper and write down all of your debt obligations. Write down the company name, the outstanding balance, the interest rate and the minimum monthly payments. You are going to call each one of these companies and try to negotiate a lower interest rate. It’s not always a successful task, but sometimes it is.
Next, we are going to plan an aggressive payment attack. My suggestion is to tackle the debt obligation with the highest interest rate first. This is your most expensive debt and is going to suck up most of your resources. So, you are going to make the minimum payments on all your other debt so that you don’t get hit with late payment fees. Remember, your student loan, if you have one, is likely at 0% interest until January 2021 and probably at $0 monthly payments, but double check just in case you have a private loan or refinanced a while back. With your highest interest rate debt, you are going to pay as much as you possibly can each month until it’s gone. Once it’s gone, you then work on your next highest interest rate card and then your next until you are debt free!!!
Now, some popular programs out there will recommend that you pay off the card or the account with the lowest balance first. This is another strategy you can use. There is a psychological thing that happens to you when you pay off the lowest balance, even if it’s not the highest interest rate. It’s a mini goal that motivates you to pay off your debt. We’re talking mind games here. You know yourself best. In an ideal world, the highest interest rate account should be tackled first. However, it may be the account with the highest balance as well, and might take a long time to pay off. You’ll need discipline to make the big payments month after month until it’s gone. Or you could pay off the lowest balance account first and give yourself a pat on the back. So, you need to decide if you need a mini-goal or if you just need to start, as they say, “eating the frog” and paying off your most expensive debt obligation.
So three thoughts about the best way to pay off your debt. First, really try not to use your retirement accounts. Instead, look at your budget and find ways you can squeeze more money out of your monthly living expenses to pay down your debt.
Next, list all of your debt obligations with the company name, current balance, the interest rate and minimum monthly payments. Then call each company to see if they can lower your interest rate for you.
Third, make a plan of attack. You’ll pay the minimum monthly payments on everything except the account with the highest interest rate (or lowest balance). You’ll throw as much as you can at that account until it’s completely paid off. Then, you’ll work on the next account and then the next until you’re done and debt free!
If you would like to talk to me about it, no charge, send me an email, give me a call, and I’m happy to walk you through this exercise and point you in the right direction. Good luck!
Thank you for watching. See you next time.
