In our last episode, we talked about the Trinity Study and calculating your FI number. So now you have a goal you are aiming for. But I promised to help you actually GET there. As we discussed, this won’t happen overnight. The goal is to set up your saving and spending so that you can maximize the amount you are putting toward the goal of financial independence. For some people, they may go bare bones, “rice and beans” for a few years to accelerate the process. If that works for you, go for it. But you don’t have to cut out all the fun on the journey, you just need to make good choices about what is actually important to you, and where you can save without feeling deprived.
Let’s Talk About Debt, Baby…
If you want to increase the amount of money you can save toward your FI number, the BEST way to do that is to get rid of most debt you are carrying. This article from Forbes shows the truly staggering state of student loan debt in the United States. More than 50% of students take out student loans, and owe on average about $29,000. But it’s not just recent college graduates who are wrestling with this. What really caught my attention was that the highest number of borrowers who owe over $100,000 are between 35-49, and that there are 2.4 million borrowers over age 62! Still paying student loans in retirement. It’s not unusual for a college graduate to be paying hundreds of dollars monthly in student loans. Imagine how much faster you could reach your FI number if those hundreds of dollars monthly were growing in the stock market instead of paying interest on student loans?
And we haven’t even begun to talk about consumer debt. Interest rates on credit cards can be as high as 26.99% (maybe higher), meaning that for every month you carry a balance, that balance is growing significantly if you aren’t paying it off. It’s easy to finance a large purchase like a car or a couch, but if your financing includes a high interest rate, that purchase is costing you a lot more than is shown on the price tag.
And finally we have debt for real estate, i.e. mortgages. This is a little different because usually a house gains value, so your mortgage is helping you buy something that will actually make you money. It’s still important to realize that you are paying more than sticker price because you pay interest on your mortgage. However, real estate is an asset, and the equity in your home can be part of your FI number calculation. Amongst those who aspire to FIRE, people are pretty split about whether it is better to pay of your mortgage early, or keep it for the long term. So we’ll leave that for the time being. But let’s go back to the other two categories.
My Debt Story
I went into student loan debt twice. In fact, just as I paid off my first set of student loans, I started taking out more when I went back to school. All told I did take out more than $100,000 in student loans, for two degrees over four and a half years. And then I took advantage of consolidation and loan forgiveness programs as well as using some of my already-accumulated investment dollars to pay off these loans as quickly as possible.
I earned a graduate degree in Criminology for which I took out $24,500 in federal student loans for a one-year program. $18,500 was federal Stafford Loans, the maximum allowed for a year of graduate school. I also took out a Perkins Loan for $6,000. When I finished graduate school, interest rates were low and I decided to consolidate my loans. I knew I wanted to work in law enforcement, and if I did then I could get the Perkins Loan cancelled over time. But not if I consolidated it with the other loans. So I only consolidated the Stafford Loans, giving me a very low interest rate on that consolidated loan, and a higher interest rate on the Perkins, but a chance to have it cancelled. I paid these loans for three years before I started working in law enforcement. My job also had a student loan repayment program available; if I was accepted (I was) they would give me $8,000 per year (before taxes, so more like $6,500 per year) for three years to pay off my student loans, in exchange for a three-year service commitment.
So, over the first three years of my new law enforcement job, I received loan repayment money from my company, which went directly to paying off the consolidated loan. Because of these lump sum repayments I was no longer making monthly payments, but interest was still accruing. As for the Perkins Loan, for that program, I submitted paperwork verified I worked in law enforcement and was entitled to loan cancellation. The loan was deferred for cancellation and after a year of working in law enforcement, a percentage of the remaining loan was cancelled. I had to re-submit this paperwork every year, but the program was set up that the whole loan would be cancelled after five years of law enforcement work.
I worked for that company for six years, so I was able to get most of the Perkins Loan cancelled (I had been paying on it for three years initially) and three years of loan repayment (about $19,500) on my consolidated loan. I had the option to start another round of student loan repayment, with another three year service commitment. However, I had started law school by then and did not know what I would be doing when I graduated, so I didn’t want to commit to another three years with the company. So I decided not to apply for another round of loan repayment. At this point I didn’t owe much left on the consolidated loan, and I just decided to pay off the rest myself by selling some investments. Good-bye graduate student loans!
Of course, now I was accumulating more loans for law school. I took out loans to cover my tuition for seven semesters and three summer sessions. I was working full time throughout law school, so I had an income, and I did not take out loans to cover living expenses or books. But I still ended up with over $100,000 in student loans for this degree. When I was finishing school, I was hired for an entry level legal position at another public service agency. One of the perks of the hiring program was a student loan repayment program; since lawyer going to private practice usually started at a higher salary, the student loan repayment was one of the incentives offered for new lawyers to enter public service. Unfortunately, after starting in this new position I was told the loan repayment was not a perk, it was a program I could apply for, but it was not given to everyone. A bit of bait and switch from how it was described in the job offer I received. I was not accepted to the program. But I was in public service, and I knew that if I paid on my loans for ten years, I would be eligible to have the rest of the loans cancelled. But this would require making minimum payments and stretching the repayment for more than ten years, meaning more interest payments overall. And after this initial bait and switch I was not convinced I wanted to stay with the agency, or in public service for ten years. I didn’t want to lock myself into that.
Unfortunately, I had the funds to pay off my student loans in full. I say unfortunately because the only reason I had this money available was because my father passed away while I was in law school, and this money was investments he had left me. I knew I could leave the money invested and it would grow, but I had not yet discovered FIRE and I was not (consciously) on the path to financial independence. I decided that my dad, who had also been a lawyer, would have approved of my using this money to pay off my law school student loans. I don’t think I made any monthly payments on these loans, because once I found out I wouldn’t be getting the student loan repayment, I sold enough of my stocks to pay it off in full.
I briefly held a car loan. When I started my law enforcement job, I bought a new car. I was actually prepared to pay cash for it, but at that time the loan interest rate was lower than my savings interest rate. I actually saved money by having the car loan, because the money I would have paid for the car was earning more interest in my savings account than I was being charged in interest on the car loan. I took out a three year loan and made payments of $450 per month. About 15 months after I bought the car my savings account lowered its interest rate (this was 2009, mid-recession, and every bank was dropping interest rates on savings accounts). Since I was no longer earning more interest from savings than I was paying for the car, it no longer made sense to keep the loan, so I used that money in savings to pay off the car. I drove that car for the next 12 years, until I sold everything this year. I didn’t sell the car when I left in February, but when I came home to visit in May, I sold it on Facebook Marketplace. The used car market is really good at the moment, and I was able to sell it for more than I had estimated it was worth.
I have never held any other consumer debt, and I paid off my student loans years before I discovered FIRE. The only debt I carried was my mortgage. I bought my condo in 2009, during the recession, and sold it at the beginning of 2022, right before another decline in the stock market (it’s too soon to declare it another recession). I refinanced my mortgage twice, lowering my interest rate and monthly payments so I could put more money into savings every month but would pay more interest over the life of the loan. When I sold my condo it had gone up in value and I had been making payments for 13 years. Meaning I had a lot of equity in the the home. This loan and making regular payments had also helped me build a good credit score. So when I sold my home, that equity put me comfortably over my FI number (which is good, because the stock market tumbled right after!)
So What Should You Take From This?
I realize most people may not have the ability to pay off $100,000-worth of debt in one fell swoop. I assure you, I would have preferred to not have received that inheritance and to have had the student loans. I think it’s important to realize that everyone’s situation is different, but everyone can make progress toward paying off debt, no matter where they are starting from. The most important lessons I can offer are:
- Read the Fine Print. If I hadn’t read the terms and conditions on my different loans I would not have known I could have $6,000 of debt cancelled just for doing the job I was doing, or that if I had consolidated that loan I would have no longer qualified for that cancellation.
- Get Creative. I used a variety of methods and options to reduce my grad school debts, including consolidation, loan repayment, and loan forgiveness. I opted to continue working during law school, and not take out the maximum for law school because I had an income to support my living expenses, and only took out loans for tuition. You can use a variety of methods to reduce or pay off your debt; and keep looking for new ways to make progress. We’ll discuss some of these.
- Consider the Return on Your Investment (ROI). When you buy something on credit and then accumulate interest charges, that item (usually) costs more than the sticker price. The exception being a situation like my car loan, where the interest rate for the car loan was lower than the interest rate on my savings account, so I was making more interest in my savings account than I was paying on the car loan. But usually, your interest charges will increase how much you are paying for that item overall. So if you finance a new couch that with a sticker price of $1,000, but you are paying interest for three years, your new couch ends up costing a lot more that that $1,000. Same goes true for taking out education loans. Will the degree you obtain allow you to pay back those loans?
This seems like a good place for a disclaimer that I am not a financial advisor, my advice here is my own and for entertainment purposes.
How Do I Even Begin To Pay Off My Debt?
Okay, you’ve heard my story, so now it’s your turn. The first thing to do is get organized. If you’re not as into lists and spreadsheets as I am, you may not have ever listed your debts in one place. So that’s the first thing to do. List all of you debts, how much you owe for each, the minimum payments, and the interest rate you’re paying for each loan. You probably don’t know all of this off the top of your head, so dig around through bills or online payment systems to gather all of this in one place. Now to come up with a plan to pay it off.
Debt Snowball vs. Debt Avalanche
There are two primary methods financial advisors promote to pay off your debts: the debt snowball or the debt avalanche.
Debt Snowball
The debt snowball is promoted by Dave Ramsey as one of his Baby Steps. I don’t agree with all of Dave Ramsey’s teachings (he is very against using credit, but I think it can be beneficial if used responsibly), but I do think his method can be a good way to get started on building wealth. The debt snowball method focuses on paying off debts smallest to largest, with no regard for the interest rate.
- List your debts from smallest to largest regardless of interest rate.
- Make minimum payments on all your debts except the smallest.
- Pay as much as possible on your smallest debt until it is paid off.
- Move to the next smallest debt and repeat steps 1-3 until each debt is paid in full.
The theory is that by starting with the smallest debt, you achieve a win quickly, which motivates you to keep going, and even speed up your debt payoff. Once you’ve paid off the smallest debt, you roll all the money you’ve been putting toward that debt into the next smallest debt, and then the next, until by the time you reach the largest debt, your snowball has grown much bigger than when you started and you can plow through that largest debt (pun intended). The additional interest you may pay by ignoring higher interest rate debts is counteracted by the momentum you are gaining as you go.
Debt Avalanche
The debt avalanche method focuses on the highest interest rate first.
- List your debts from highest to lowest interest rate regardless of balance.
- Make minimum payments on all your debts except the one with the highest interest rate.
- Pay as much as possible on the debt with the largest interest rate until it is paid off.
- Move to the debt with the next highest interest rate and repeat steps 1-3 until each debt is paid in full.
The theory here is that by focusing on the largest interest rate first, over time you will pay less in interest, and less money to debt overall. The challenge is that your largest debt may be the first you pay off, or somewhere in the middle, and can feel like an overwhelming task. With the snowball method that largest debt will always be last and you’ll approach it with momentum.
It’s a personal decision which method you want to follow. Or you could follow a hybrid of the two; start with the smallest debts to get some early wins and gain some momentum, then switch to the higher interest rate debts, and maybe save the largest dollar amount to the very end. The important part is to continue to make all your minimum payments so you aren’t delinquent on any of your debts, and to then put all the extra money you can to one debt at a time. Once that debt is gone, focus on the next one, and put all your extra money toward that debt.
What If My Interest Is Burying Me?
Interest rates can really kill your plan to pay off debt. I have some cards with interest rates of 26.99% APR, meaning for $100 dollars I don’t pay off each month, I’d be charged $26.99, which would just add to my debt burden. I never carry a balance on my cards, but if I did, I would be really unhappy to have to pay an additional 26.99% of money and not getting anything for it, just because I hadn’t paid off my card yet. In fact, if I was carrying a balance, there are a few things I would do to try to reduce the interests rates I was getting charged, while I worked on paying off the total debt.
Debt Consolidation
I mentioned above that I used debt consolidation for some of my student loans. Consolidating your debt means that you are taking our a new, consolidated, personal loan for the full amount of debt you owe (or for the amount you are consolidating) and getting one interest rate for the whole amount. It’s usually somewhere between the highest interest rate you’re paying and the lowest. This new loan will pay off the individual debts, and then you’ll pay the new lender directly. The terms you’re offered will depend on the debt consolidation company you use, your credit score and repayment history, the amount you’re consolidating, and the daily interest rates.
If you are considering going this route, keep in mind that some debt consolidation loans charge an origination fee, early payment penalties, late fees, etc. You should obtain rates and terms from multiple companies and compare them. Make sure you know the ins and outs of each loan (i.e. read the fine print), and that you have included any additional fees in your calculation of which company will be the best fit for you. Also consider different combinations of which loans to consolidate. As I said above, I left one of my loans out of my student loan consolidation because I knew I had another option to get rid of that loan. When you are consolidating, it might not make sense to include a small amount at a low interest rate if your new interest rate would significantly increase how much you’d be paying on that individual loan.
Balance Transfers
Have you received offers in the mail for new credit cards, and one of the benefits offered is a no interest or low interest balance transfer? If you have a credit card that charges you 26.99% APR, moving that balance to a card that doesn’t charge any interest for a year, or only charges 5.99% APR can save you a lot of money and help you make progress toward getting rid of that debt entirely. If you have this opportunity, either with a new or existing credit card, make sure you again read the terms and conditions. The new card might charge a fee for the transfer, or if it’s a promotion for a limited time the interest rate after that time period ends might be higher than the one you started with. But, if you can transfer a balance to a new card that offers you a year with no interest, and you can pay off that card within that year, you may be able to save yourself a significant amount of money in interest, while also having motivation to focus on that debt. But be careful not to fall into the trap of just moving the debt from one card to the next and not paying it down; a balance transfer should be used as a tool to help you get rid of your debt, not to just put off having to deal with it.
Payment Plan
If your debt outweighs your income and you are unable to keep up with your minimum payments, your debt may be delinquent or even in default. You need to take steps to get in a position where you can make a dent and don’t keep accumulating more debt that you don’t have the funds to pay. Creditors want you to pay them back. If you stop making payments they can send your debt to collections, but this isn’t ideal for them either. They sell the debt, only receiving a portion of the full amount and then the collection agency tries aggressive tactics to get the money back from you, because they keep the difference between what they bought it for and what they can get from you.
All this is to say that your creditor may be willing to negotiate your debt if you contact them directly. They have options– they can lower your interest rate for a time period so you can make progress toward paying off the debt; they can take a lump sum payoff for a percentage of the total, and wipe away the debt. There may be some side-effects; your credit score can take a hit and the creditor may close your account. But this may be a way to jump start your consumer debt payoff even if you’re working with limited funds. If you go this route, make sure to get any agreement with your creditor in writing.
Credit Counseling/Debt Settlement Companies
There are non-profit and for-profit companies that can work as a third party on your behalf to help you pay off your debt. You pay for these services and then they do the negotiation with your creditors on your behalf. If it were me, I would try to negotiate with my creditor on my own first; I don’t want to pay someone else to do something I can do myself. If I was unable to make any headway on my own I might look into these options, but it would be almost my last resort.
Bankruptcy
I think this should be the absolute last thing you should consider. It may seem easy to file for bankruptcy and then start from scratch, but a bankruptcy stays on your credit history and effects your finances for years after it is filed. Also, a bankruptcy doesn’t wipe out everything, for instance student loans. If you are considering filing for bankruptcy, then you should stop reading this and find a financial advisor or bankruptcy attorney to go over your situation in detail and determine if that is the path to follow.
That’s a Lot.
Yes, yes it is. I apologize for the super long article, but debt is a huge hurdle in moving toward financial independence, and coming up with a plan to get it under control or get rid of it entirely is vital. Getting a handle on your debt situation should be one of the first things you do in planning for financial independence. That’s not to say you can’t make progress toward your FI number yet. You can pursue saving for retirement and building wealth at the same time you are paying off debt. There are certain wealth building tools you should start using as soon as possible and not wait until your debt is gone. But, once you’ve eliminated your student loan and consumer debt, all the money you were paying toward those loan payments can then be reallocated toward reaching your FI number, and suddenly you are putting large sums of money toward that early retirement goal!
Next we’ll look at some of the vehicles you can start using to save for retirement, including retirement and non-retirement investment accounts, and how to balance getting started with investing with continuing to pay off debt. You may also be finding that since you are now tracking your spending and are more aware of where your money is going, your spending habits are beginning to change and you have more money to put towards debt or investing. Great! We’ll discuss what to do with that extra soon.