Good ‘ol debt. Something we’re not often taught about and are left to our own devices to figure it out for ourselves. A lot like personal finance in general!
The thing is, debt can be dangerous if not understood properly and misused. Things like, students taking out loans that are way more than they’ll make in one year’s worth of salary; or not paying off credit card balances monthly.
But debt can also be useful when used properly. Like taking out a mortgage to purchase a home that will increase in value over time. Or making purchases to get rewards or travel points.
Common Types of Debt in Your Twenties
- Student Loans
Raise your hand if you have student loan debt 🙋♀️. In your twenties, you’re likely at a point where you’ve already taken out your student loans and now you need to figure out how to pay them back.
Know how much you owe, what your interest rate is, and educate yourself on what options you have available for repaying your loans. Understand that you have a 6-month grace period after graduating before you are required to repay your loans.
Standard repayment is 10-years, some repayment programs offer 20-years. That doesn’t mean you should take that entire time frame to pay back your loans. Evaluate your other goals and determine if it’s important enough to you and manageable to repay them more quickly.
- Auto Loans
In our twenties, we’re likely getting new (or new to us) cars. That old beater car we drove through high school and college needs to be replaced. You likely won’t have the cash to pay for a car out of pocket, but if you do KUDOS! So, most people finance a portion of the cost of the car.
*Be careful with auto loans. Cars are referred to as a depreciating asset, this means they lose value over time. So, when you finance a new vehicle, the value automatically drops and is likely worth LESS than the amount of debt you just took on to purchase it.
Don’t use this opportunity to finance more car than you can actually afford. Often times dealerships are offering 72-month financing with zero percent interest. No.
A good rule of thumb, your transportation budget shouldn’t exceed 15% of your take-home pay and you should keep your term at 48-months or less. Below is a quick affordability worksheet to help you determine how much car you can actually afford.
Quick Affordability worksheet
- Credit Cards
I’ll be honest with you. I’m a financial advisor and I had a bad relationship with credit cards for years. I never got to a point where I was carrying a hefty balance, and I didn’t open my first credit card until I was 21. But I used it as an excuse to be able to “afford” my wants (Yet again, thanks Target) and I was dipping into savings to pay off my balance. This was unhealthy.
If you have the self-control to use them properly, then use them to your advantage. Rack up those rewards or travel points. But always make sure to payoff your balance each month in full, because average interest rates are hovering right around 20%.
Buying a home in your twenties is becoming less and less common. BUT if you are someone who wants to get into that ownership game, mortgages are going to help you get there. Mortgages are often seen as good debt, since you’re financing the purchase of an asset that will appreciate in value over time.
Identify your relationship with debt
Not everyone feels the same way about debt. Some people see certain types of debt as good debt (mortgages, student loans) or bad debt (credit cards, auto loans). And some people think all debt is bad debt. Debt is good when it can be leveraged, but if you don’t know how to use debt to your advantage then proceed with caution.
If you’re struggling to pay the minimum on your credit card or you’re not paying your balance in full, this is a good identifier that you don’t have a great relationship with debt.
When should I pay down debt vs prioritize other financial goals?
- Compare interest rates to potential return elsewhere
I often get asked the question of whether or not clients should pay down their student loans or invest more. There isn’t a one size fits all answer, but you should consider your interest rate compared to what you could achieve in the market.
Assume your student loan interest rate is 4.75%, you’re torn between paying down your student loans versus investing more for retirement. Since investing for retirement is long-term, you could safely assume you’d return an average of 8% in the market. Since 8% is greater than 4.75%, it would make more financial sense to invest for retirement. However, if your interest rate is 9%, then it would make more sense to pay down that debt.
A quick rule of thumb, if you have an interest rate of 5% or greater than pay down that debt first before investing more. But if you’re under 5%, then invest.
- Identify what is important to you
You are only going to be successful at paying down debt if you’re ready and it’s in a way that is meaningful to you. If you want to travel or live on your own, then paying down your student loans early might not make the most sense for you. You need to find a balance between what is practical and being okay with making sacrifices, while also maintaining a lifestyle that is meaningful to you.
– Never carry a balance on your credit card.
– If you can’t pay cash for something, you can’t afford it! I’m talking about wants vs needs here
– Be realistic when it comes time to finance a vehicle. Often times we become enamored with all the new bells in whistles, leading to irrational decision making and purchasing more than we can truly afford.
Debt planning is one of my favorite areas to help clients. If you feel overwhelmed or need assistance, schedule a chat with me here! Your initial consult is always free and no obligation.
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Carolyn Rowland is a CERTIFIED FINANCIAL PLANNER™ passionate about empowering individuals to take control of their financial landscape. “We often tend to place our own priorities on the back burner for others, resulting in sacrifices we don’t often realize we’re making.”Carolyn believes in taking a values-based approach to financial planning. “Together we’ll define what matters most to you, what you want your life to look like, and develop a plan that fits your lifestyle.”CC
Carolyn Rowland is in the Milwaukee WI, area.