Money, Honey: Bills, Bills Bills: Loans and Debt Edition

Sometimes, you gotta borrow money to do your thing.  Like lots of money.  Like more money than you can imagine having.  Almost every young person I know owes student loans to the tune of twenty, forty, or eighty thousand dollars.  There's tons of great writing on the student loan crisis and its impact on the economy so I'm not going to rehash that here, but it's worth checking out.  I personally have student loans to the tune of about $20,000 and an auto loan I owe $7,000 on.  I use a credit card but don't have credit card debt, though a lot of amateur adults do.  Many of us started borrowing money before we fully understood the whole process, but if you're getting a handle on your finances in your early 20s, you're still in pretty good shape.

Wait a minute!  I want to be responsible and stuff, but this stuff is so confusing!  There are so many WORDS what do they even mean? Fear not, I've done the Googling for all of us.

Interest is simply the money you pay to borrow money. Your rate is determined by your credit, but different types of loans have different general ranges.  The average credit card rate is around 15%, while the average 15 year mortgage is currently at 3.15%.  So although great credit can help you get decent interest rates, some kinds of debt cost much more than others.

APR stands for Annual Percentage Rate.  Basically, it's how much interest you will be paying on the debt each year.  So let's say we're looking at a credit card debt of  $3,000 (compared to the US average of $15,950 according to creditcard.com) and a "reasonable" 17% APR, if you carry that balance for a year (keep owing the dough without paying) you'll owe $3,510 at the end of that year.  That's assuming that you aren't adding to that debt at all.

Compound Interest means paying interest not only on the principle (how much money you borrowed the day you signed the papers) but also paying interest on the interest you've already accrued (literally means "built up", but is finance-themed). Interest is typically compounded annually or quarterly (there are four quarters in a year, so they last 3 months).  Ideally, money you owe will be compounded infrequently, and money you are saving will be compounded as often as possible.

Skip this next paragraph if you can't even with numbers right now.

Let's revisit our imaginary credit card debt.  If your interest is compounded annually you'll owe that $3,510 at the end of the first year, and then after the next year it will be up to $4,106.70.  The picture is even uglier if it compounds quarterly. 

Seventeen percent annually works out to 4.25% quarterly.  After your first quarter $3,000 becomes $3,135.  Because of the magic of compound interest, you also have to pay interest on that $135, making your total for the next quarter $3,276.08.  By the end of the first year you owe $3,543.44, and after two years you're up to $4,185.33.  The difference between compounded annually and quarterly  isn't huge in this example, but the longer you carry your debt for, the more it matters.

I'm not trying to overwhelm you here, so if you can only take one thing out of this have it be this: The nitty gritty details of your loan and carrying debt from year to year make a huge difference in how much money you will pay.

Credit card debt is the the nasty one.  If you don't have any, avoid building it up.  If you do, start working immediately on paying it down.  No more making the minimum payment, often it won't even keep you ahead on interest.  So though you're paying each month you're still going deeper into debt. Although they often offer a decent introductory rate near 2%, after the first year you'll be paying crazy interest.  The average on new cards is just over 15% and without established credit you can expect closer to 20%.  After my first year ends, my AAA Visa jumps to 24%.  I'm talking here about rates for stuff you buy, but transfers and cash withdrawals often have different rates.

Obviously in an ideal world, we wouldn't have debt. But we already do, and we sometimes need to take on more. So work to not take on debt you don't need, and to live a lifestyle you can afford.  But here are my top tips for paying down the money you owe:

1. Make paying your debt a priority.  Cultivate a sense of satisfaction that you're building your financial future whenever you make a payment, rather than throwing money into an endless hole. Listen to Grown Woman when you write checks.  If you can't afford to stay on top of your debt, you need to consider some lifestyle changes.  I promise future you will thank you.

2. Always pay extra.  Even if it's just rounding up from $237 to $250 a month you'll be done sooner which means paying less interest, and it's a great habit to get into.

3. If you are still in school or deferred while doing an eligible job/fellowship or working on a graduate degree try to pay off the interest as it accrues.  This won't be a ton of money, you can swing it.  This way, you can escape much of the cost of compound interest, and will significantly lower your debt when you start paying it off.

4. Set up direct pay for federal loans.  If you didn't pay attention during your exit interview you may have missed it, but if you set up the direct pay option on FedLoan (or whoever your servicer is) your interest rate will decrease by .25% over the life of your loan (they give you 10 years) that's big money, plus it's easy and convenient for you.

I know how easy it is to feel like you're drowning, even when your debt is completely under control.  But, as my Dad recently mentioned, consistency is key when if comes to paying you debts, so just set yourself on a good path and all you'll need to do is keep chugging along.